Hedging your mutual fund bets
- Alan Lavine and Gail Liberman
Forget the fancy footwork if you need to hedge your mutual funds. You even can skip the margin accounts.
Sophisticated investors now can hedge mutual funds with "inverse funds." These funds even can be used inside a retirement account.
Inverse mutual funds rise in value when their benchmark indexes decline.
Say you own bond mutual funds. The problem: Bond prices and interest rates move in opposite directions. So when interest rates rise, bond prices fall. To offset this potential, you can buy an inverse bond fund that will increase in value when interest rates rise. So gains in the inverse bond fund should offset losses in your regular bond fund.
There also are inverse stock funds. Mutual fund groups with inverse funds include the ProFunds and Rydex Investments.
"Investment advisors and sophisticated investors are embracing more advanced strategies than traditional buy-and-hold, including hedging portfolios to protect gains," says Michael Sapir, Chairman and CEO of ProFund Advisors LLC. "Short or UltraShort ProFunds can effectively reduce an investor's exposure to a certain sector without having to sell any of a position."
Sapir gives this example.
Say you have $60,000 international equity exposure and are worried about a short-term correction. You would like to temporarily cut exposure by half. Rather than sell half your position and perhaps, realize a taxable gain, you could purchase $15,000 of UltraShort International ProFund. This provides double inverse exposure to the MSCI EAFE Index, effectively reducing your foreign equity exposure by $30,000. If the MSCI EAFE index decreases by 1 percent, the fund rises by 2 percent. If the index rises by 1 percent, the fund falls 2 percent in value. To remove the hedge, simply sell the fund shares.
A word to the wise: You need to know what you're doing when you attempt to hedge your mutual funds. Use an inverse fund at the wrong time, and it will decline in value, while your regular mutual fund increases in value. So you risk losing your gains.
You need to have a market timing system or hire a professional money manager to help you hedge your funds.
We maintain that for the average investor, dollar cost averaging is the best way to invest. Simply invest in your mutual fund monthly through thick and thin over the long term. When your fund's share price declines, you accumulate more shares at a lower cost. Over the long haul, the average cost of your investment should wind up less than the market price.
Spouses Gail Liberman and Alan Lavine are syndicated columnists. Their latest book is "Rags to Retirement (Alpha Books)." You can e-mail them at MWliblav@aol.com.
To read more columns, please visit the column archive.