7 Ways to Hedge against Volatile Markets

Investors and markets are facing one of the highest degrees of uncertainty since the beginning of the COVID-19 pandemic. For example, CBOE Volatility Index (VIX) surged over 80 on 16th March 2020, surpassing its 2008 record. S&P500 and Nasdaq Composite indices dropped by 12 per cent on 16th March 2020. On the same day, the Wall Street Journal reported that Dow Jones Industrial Average (DJIA) dropped over 12 per cent ‘marking the second-worst day in its 124-year history.

Such volatility has many investors reconsidering or at least rethinking their their investment strategies. This is especially true for novice investors, who can often be tempted to pull out of the market altogether and wait on the sidelines until it seems safe to dive back in.

The thing to realise is that market volatility is inevitable. It's the nature of the markets to move up and down over the short-term. Trying to time the market is extremely difficult, if not impossible. One solution is to maintain a long-term horizon and ignore the short-term fluctuations.

For many investors, this is a solid strategy, but even long-term investors should know about volatile markets and the steps that can help them hedge against this volatility. In today's article, we'll show you how to do just that.

#1: Stick To Cash

Cash investments such as savings accounts, money market accounts and certificates of deposit offer a “respite from the ups and downs of the market". The ongoing issues with the coronavirus, oil price war and liquidity stress drives many investors to cash. Cash not only provides agility during these uncertain times, but it also dampens volatility.

#2: Invest in Precious Metals

Gold and other precious metals are known as safe havens during periods of high market volatility and often move in the opposite direction. Owning physical gold coins or bars, either at home or in a secured vault is the way to go. Alternatively, investors who don't like the idea of owning physical gold due to its lack of perceived liquidity can invest in individual gold miners and/or several gold miners through an ETF.

#3: Invest in Real Estate

Investors should diversify their portfolios with a healthy allocation of 20% to 30% of illiquid real asset investments with funds in real estate, infrastructure and natural resources to act as a ballast. Cell towers, commercial properties, data centres, single-family rentals and apartments are good hedges against the eventual recession.

#4: Invest in Defensive/Value Stocks

Shore up your portfolio with defensive sectors such as consumer staples and utilities with a consistent nature of business. Consider adding an ETF that focuses on companies with a strong return on assets growth.

#5: Hedge Using Options

One way investors can help protect themselves in volatile markets is to consider incorporating options. Options can hedge existing positions in your portfolio or the portfolio in its entirety to help reduce risk.

#6: Invest in Short Term Government Bonds

During times of market uncertainty, it can make sense to have a substantial portion of your portfolio allocated to Treasury bonds. While Treasuries can immediately provide ballast to market volatility, they are not good long-term investments as they can't keep pace with inflation.

#7: Add Investment-Grade Bonds

By adding assets that have lower volatility to equities, you can reduce portfolio volatility. However, by adding uncorrelated or lowly correlated assets, portfolio volatility can also be reduced. The assets that remain uncorrelated are aggregate bonds, mortgage-backed securities, Treasuries and Treasury inflation-protected securities. Investment-grade bonds have far lower volatility than stocks and are generally uncorrelated to stocks.

In Closing...

Investors need to be aware of the potential risks during times of volatility. Choosing to stay invested can be a great option if you're confident in your strategy. If, however, you feel like you can't handle spikes in volatility, hedge by investing in these vehicles.