A reader asked how exactly does one get defensive in a portfolio, a concept I write quite a bit about but should probably give time to defining.
I think the exact manner in which I would get defensive would depend on the circumstance. For example, twice in the last year and a half the market went below its 200 DMA, but not for long. I took action both times (and detailed it on this site) by only selling one or two names to start but then the market went back above.
One thing I would say is the bear markets don't start with crashes. If we dropped 5% on Monday because of a terror event of unprecedented scale I would not sell into that knee jerk reaction. As we saw with Katrina some portion will unwind, even if after the unwind it goes down again.
In getting defensive I would sell some stock. Maybe partial positions of a lot of stocks or entire positions of fewer stocks, it would depend on when we got there. I would use some cash to buy more short dated preferreds. If there is a need to get defensive soon my plan is to add a couple of more foreign names. I might add a little more to inverse index funds. Whatever I do, there will certainly be more allocated to cash than normal.
Also I would not do this all at once. What I would do and how I would do really depends but all at once allows little margin if I am wrong.
For example if I started getting defensive right now by reducing net exposure to US stocks by 10% and then the market went down by 5%, I'd probably be in better shape than the market and we'd still be in down a little territory. If I then took another 15% off the table the volatility and correlation of the portfolio would now be quite far from the market. Also add in that an inverse index fund would be carrying more weight at this point.
If, as I was making these changes, the market dropped another 10% I think I would have a very good chance of having missed a decent chunk of the roughly 15% down in this scenario.
As I look at things, if the market goes down 15% and clients' long term money is only down 8% or 9% I have added value.
There is no guarantee how this type of plan will work out but all I am trying to do is put the odds in my favor. Any plan may work out better or worse than hoped for but I think it is better to have some sort of plan than none at all. And that is the point.
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6 comments:
Concerning preferreds. Can you suggest any methods, tools, resources for selecting candidates?
A resource that I use to help select preferred stocks is quantumonline.com
I like RNAI. Do you have an opinion?
mee too on quantumonline
I don't know RNAI well enough to have an opinion.
Preferreds tend to have large bid/ask spreads. So what are your entry/exit mechanics? Limit orders and risk missing the boat? or market orders in the interest of making the porfolio right?
as for exit entry;
the spreads are wide due to a lack of volume. This means that the specialist runs the risk of holding on to product longer with a preferred than a more liquid common.
trades can get done in between the bid ask but you should not expect to buy on the bid. if the spread is $0.20, I think you have a reasonable chance of getting executed by using a limit that gives the specialst $0.15. no guarantees.
If the specialist will in fact execute a limit order in the manner I describe, he will do it right away. If not, you are then waiting for a natural trade to take the other side and that could take a while.
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