Hedging Your Portfolio with Reverse ETFs

When your outlook on the stock market turns bearish, selling your entire portfolio (or part of it) isn't the only option to reduce risk. A practical alternative is investing in a reverse or inverse ETF, which profits when the market declines. These ETFs are traded like regular ETFs through any broker and offer a straightforward way to hedge against market downturns.

Using Reverse ETFs Conservatively 

The primary use of a reverse ETF is to hedge your portfolio, not to speculate on market declines. Here's an example:

- Portfolio: $100,000 in stocks and $50,000 in cash.

- Hedge: Allocate $20,000 to a 3x leveraged reverse ETF.

This hedge provides approximate coverage for market drops, as the ETF is designed to move inversely to the market on a daily basis. While the calculation isn't perfect—because reverse ETFs are optimized for daily performance—the hedge can offset some losses if the market falls.

Which Reverse ETF Should You Buy? 

Choose the ETF that matches the market or sector you expect to decline the most. For example, if you anticipate the Nasdaq dropping more than the general market, you might consider a reverse ETF tied to that index. Leveraged options (e.g., 2x or 3x) amplify gains and losses, making them more volatile but potentially more effective for hedging small cash allocations.

Key Considerations

- Reverse ETFs are meant for short-term strategies, as their performance may deviate from expectations over longer periods.

- Not for Speculation: These are tools for protection, not gambling on a bear market.

- Alternative Protection: Selling part of your portfolio remains a valid option for managing risk.

For those interested, here’s a link to tickers of commonly used inverse ETFs.

Are they really fighting?

Take a look at this chart. It's a visualization of the S&P 500 divided by the price of gold—basically, what happens when you price the stock market in gold instead of dollars. The result? A story of financial cycles that many miss if they only focus on stocks or only on gold. This chart doesn’t just show market moves; it shows when one asset reigns supreme over the other.

In times when the line trends upwards, it's better to own stocks. Confidence is high, economies are expanding, and the return on equities outpaces the stability gold offers. But when the chart takes a sharp dive? That’s gold's time to shine. These moments represent financial turbulence, recession fears, or market corrections, where investors seek safety in gold’s enduring value.

Now, here's the kicker. Many analysts believe we’re on the verge of another significant downward leg in this chart. If that proves true, it would mean a shift in favor of gold over stocks—a warning shot for those clinging too tightly to equities. But let’s be clear, nothing is certain. What this chart does tell us is that these shifts happen, and when they do, it’s dramatic. Watching for these changes can make all the difference.

That said, it’s not about being all in on gold or stocks. The real strategy is balance. Holding both assets in a portfolio, but adjusting the weight depending on which part of the cycle we're in, is the key. Early in a downward segment? You might tilt toward gold. In the upswing? It’s time for equities to shine. Finding the exact mix is very complicated. What matters is to have the foresight to adjust the desired percentage with the cycles.

This isn’t advice—it’s a reminder to watch the clues, understand the patterns, and adjust your strategy before the next shift catches you off guard.

Portfolio review

As you can see on the right, Portfolio Model, our portfolio is based on hedging risks. It includes stocks, gold and cash or short-term bonds.

In general, the performance is good: last year it returned 7.2% and this current year around 3% so far, basically due to the good behavior of gold.

Our 2 ETFs to track the stock market haven’t been the greatest, but they invest in solid business which pay dividends (DTN 2.7% and DOO 3.9%).

Gold finally decided to move upwards and now it is trading in uncharted territory. We still believe this is just the beginning:

As always, this is not a recommendation at all, but just a theoretical study of how gold and stocks combined can hedge market risks.

Navigating the changing World order

Allow us to provide a brief overview of the projected changes in country rankings by 2050, based on various sources including PwC's "The World in 2050" report. According to these projections, China is expected to ascend to the position of the world's largest economy by 2050, surpassing the United States. This shift is driven by China's ongoing economic growth, population size, and increasing productivity. India is also anticipated to rise significantly and potentially become the third-largest economy globally, following China and the United States.

Furthermore, other emerging economies such as Indonesia, Brazil, and Mexico are expected to experience substantial growth and climb the rankings. Meanwhile, developed economies like Japan and those in Western Europe may see a relative decline in their positions. It is important to note that these projections are subject to various factors and uncertainties, and future outcomes may differ from these estimates.

Nevertheless, recognizing the potential changes in country rankings provides retail investors with valuable insights for identifying investment opportunities and adjusting their strategies accordingly. In this article, we will explore practical ideas for retail investors seeking to profit in the stock market amidst the changing world order.

1. Embrace Emerging Markets:

With the projected rise of emerging economies like China, India, and Indonesia, retail investors can consider diversifying their portfolios by investing in Exchange-Traded Funds (ETFs) that focus on these growing markets. These countries boast substantial consumer bases and expanding middle classes, offering investment opportunities in various sectors.

2. Technology and Innovation:

Technological advancements continue to disrupt industries worldwide. Investors can focus on companies at the forefront of innovation, particularly in sectors like artificial intelligence, renewable energy, biotechnology, and fintech. Investing in technology-focused ETFs or individual stocks within these sectors can offer opportunities for substantial growth and profitability.

3. Infrastructure Development:

As countries invest in infrastructure projects to drive economic growth, retail investors can explore opportunities in construction, engineering, and related sectors. Investing in ETFs that track infrastructure indices or individual companies involved in large-scale infrastructure projects can potentially yield favorable returns as governments allocate resources to develop vital transportation, energy, and communication networks.

4. Diversification through Global ETFs:

In an increasingly interconnected world, diversification remains crucial for mitigating risks. Retail investors can consider investing in globally diversified ETFs that provide exposure to a broad range of international markets. These ETFs can help balance portfolios and capture opportunities across different regions and sectors.

5. Long-Term Focus:

Given the projected changes in the world order, it is essential for retail investors to maintain a long-term perspective. Rather than succumbing to short-term market fluctuations, adopting a disciplined investment approach and staying informed about global trends can help navigate the evolving landscape successfully.

Follow the hedge funds

We, mortals, have some tools to track what hedge fund managers do. Have you ever wondered how Bill Ackman is investing? Would you love to track a mix of trendy stocks in the hedge fund community?

Let us give you a couple o tips in case you are interested in tracking these famous managers:

1. Web hedgefollow.com It is still beta, but it works beautifully. Here you can track managers, stocks… with a very easy intertace.

2. ETF: GURU directly invests in highest conviction ideas from a select group of hedge funds.

The importance of owning some gold

PDM, Stichting Pensioenfonds DSM Nederland (DSM Nederland Pension Fund), manages the pensions of all companies affiliated to DSM Nederland B.V.

Recently, they have decided to open their array of investments and start reducing public bonds to buy property even gold. Very interesting link here.

As we have been saying for long time, gold doesn’t behave like the rest of investments and can hedge the risk and volatility of the stock market. You can check our PORTFOLIO on the right and you will see that is what we try to accomplish.

Owning some gold is like buying insurance for the rest of the portfolio.

Offices, office REITs?

In general, we love REITs. It is a very convenient way of owning real estate without the hassle of dealing with tenants. However, not all of them are the same. Here you have an old list of high dividend REITs.

With the rise of on-line shopping, we tried to avoid mall REITs. We felt many malls were built and only a few became successful. Besides malls, the Covid era has accentuated another global trend: working from home. This new reality we feel is likely to linger on.

When the pandemic wanes, do you think employees are going to return to the office?

Some financial firms are requesting their workers to return to the office as soon as possible. However, others such as Twitter, Spotity, Square... are going to let telework forever. We still don’t have enough data to value the effectiveness of the employees doing their job from home. We don’t even know if the intermediate managers are well prepared to assign specific tasks with adequate duration estimates. Probably, all of us have an opinion on the matter based on our own experiences.

That been said, the most probable outcome is going to be a hybrid model. Many big corporations (Microsoft, Maersk, etc...) have publicly announced they are willing to let employees combine work at home and at the office. There are even some office models with distributed workstations all over the cities. 

In any case, office space is going to suffer the consequences of more people zooming. There are REITs that only invest in offices. We never liked them. However most of the big REITs invest a big part of their capital in offices. It is up to you to decide if it is worth it.

Remember: before buying a REIT check the portfolio they own to have a clear idea of what you are buying.

Reminder: where and how to buy gold?

You feel gold is soaring..., at historical maxima in most currencies. For years, we have been advising that it would happen and some of you think that you missed it. Not so sure. The long-term perspective is brilliant, like gold itself. But in case you want to join the race, how do you buy it?

Very easy. We would give you some ideas here:

1. Go to your broker and buy an ETF of gold backed by physical gold. Many good ones. Just google it.
2. You can buy gold on/in the ground. How? You can buy gold mines. They are going to work as a mix between gold and the stock market. You can buy an ETF with several big ones, GDX, or small ones, GDXJ.
3. There is a beautiful and reliable program in Australia, called Perth Mint (link here). Check the list of distributors in your country.
4. Why not having bullions or non-numismatic coins directly? You can go to the shop or buy online. The only problem here is the storage (bank or private safe, house...). You do your maths.
5. Some firms offer the purchase and the storage in their safes under your name. It is a very efficient way of buying, but don’t feel confortable recommending specific names.

Remember if you hold stocks, it could be a good idea to own some gold, taking advantage of the negative correlation.

If we want to buy..., which stocks?

Here, we are not going to solve your doubts about the World collapsing or recovering. It is your decision to think one way or the other. However, if you believe there will be a recovery at the end of this year or next year, perhaps, it can be a very good opportunity to buy some high-quality shares which were unavailable some months ago (extremely high P/E ratios).

This is going to be a dense article, so let us start saying that these moments can be excellent to rebalance your portfolio and/or changing from funds to good shares.

Second question that arises is when we should start buying -please, again, if you believe the pandemic will get under control. We have not good solution for that. Be ready to receive the worst news in the US, etc.. Perhaps, starting in May, we can commence with a program of partial purchases. In any case, to find the best trigger, just remember:

“The time to buy is when there is blood in the streets. Even if it is your own." Baron Rothschild.

Third, our target in SimplyNoRisk is not to get the best returns, but to suffer the least, therefore our stock picking is very defensive. We believe the following sectors can be good options:

Utilities: JXI ETF,

Healthcare: Parkway Life REIT, IXJ ETF,

Food and beverages: Diageo, Coca-Cola, XLP ETF

Technology: Alphabet, Verizon.

Others: Deutsche Post.

And to finish, please, don’t gamble: the travel industry is doomed. The recovery might not come for many cruise lines, airlines, hotels... Also be careful with malls, restaurants, bar chains.

SOCIMI

Las SOCIMI son la versión española de los REIT (Real Estate Investment Trust). Básicamente un grupo de inversores crea una sociedad para comprar y gestionar inmuebles. Normalmente uno puede comprar participaciones de una SOCIMI en el MAB (Mercado Alternativo Bursátil).

Para el ahorrador es una forma de tener exposición al mercado inmobiliario con poco dinero y sin preocupaciones. Tiene importantes beneficios fiscales que han hecho que incluso sea un tema que recientemente se tratara en la confección de los presupuestos del estado (enlace).

El problema de las SOCIMI es su falta de liquidez (muchas apenas realizan operaciones) y la ausencia de control por parte del inversor, ya que este se tiene que adherir a lo que decidan los gestores de la SOCIMI.

Aquí tienen un listado de SOCIMI:
https://www.bolsasymercados.es/mab/esp/SOCIMI/Listado.aspx

Miren lo que compra cada una. En unos casos serán inmuebles con malas perspectivas, en las afueras, centros comerciales venidos a menos, pero también tienen algunos con carteras más sólidas. Con las SOCIMI no todo vale.

Against the Tide. Portfolio evolution

As most of the readers know, in SimplyNoRisk we try to reduce pain. When fund managers compete to see who has a greater yield every year, we observe it from a healthy distance. That is not our target, but to CONSTANTLY create a sustainable portfolio that never suffers a terrible year.

On the right of our web, you can click on Portfolio Model for an example or here for a direct link.

As we show on the chart above, we have beaten REAL inflation (we use double the official one) and the drawbacks have never been awful. For instance:

2016  8.2%
2017  9.3%
2018  -7%
2019  2.3% (until today)

The idea of this portfolio, as explained in our book, is based on Harry Browne’s permanent portfolio, but with a more realistic approach. As you can imagine, we are very happy with the results.

This could be crazy, but...

... there is a lot of money to be made if we enter into a new recession in 1 or 2 years. By the way, this scenario is very likely.

If you have read simplynorisk.com during the last years, you know we don´t like bonds in general. However, there are some exceptions to this rule. For instance, we are experimenting with P2P lending or very specific perpetual bonds for certain moments of the market. In our public portfolio we don´t hold any bond with maturity longer than 2 years.

Imagine for a second that the FED and the ECB drop the interest rates to zero in the next year or years, what happens to a 10y bond? It goes up in price..., a lot. Some people don´t know how to manage bonds, and for these people a good idea could be to buy an ETF, such as BLV (US exposure, government and corporate) or IEGZ for the investor focused on Europe. There are many options, even with leverage (3x).

Just something to think about...

Smart ETFs

As explained in the previous post, in general, an ETF tracks a simple index such as S&P 500. But also they can include some algorithm trying to achieve better returns or to reduce the risk. Here we want to show you some interesting ones:

LRGF, iShares Edge MSCI Multifactor USA. From investorplace.com: the ETF screens for stocks that meet four of the biggest determinates for success. These include financially healthy firms, stocks that are inexpensive, smaller companies and trending stocks. Better known as quality, value, size and momentum. Expense ratio: 0.2%.

SPLV, Invesco S&P 500 Low Volatility. From investorplace.com: SPLV tracks an index of stocks that exhibit the lowest realized volatility over the past 12 months or the lowest magnitude of price fluctuations over time. By betting on the least-volatile stocks, investors are able to capture plenty of upside, while limiting the drawdowns. Expense ratio: 0.25%.

ALFA, AlphaClone Alternative Alpha. From etf.com: ALFA tracks an index that aims to deliver outperformance by mimicking hedge funds' positions in US equities. The index relies on lagged published holdings to determine long exposure. Expense ratio: 0.69%.

MNA, IQ Merger Arbitrage. From etfdb.com: this ETF offers exposure to a merger arbitrage strategy that has been popular among hedge funds and other sophisticated investors for decades. By seeking to capture the gap between the ultimate transaction price and current price levels for takeover targets, MNA is capable of delivering relatively stable returns that should exhibit low correlations to asset classes such as stocks and bonds. Expense ratio: 0.78%.

The Ivy Portfolio for Europeans

One of the most famous permanent portfolios is the Ivy (League) Portfolio. You can read all about it in the book The Ivy Portfolio: How to Invest Like the Top Endowments and Avoid Bear Markets, by Eric W. Richardson and Mebane T. Faber (link).

The basic idea is to keep a fixed portfolio and rebalance it every once in a while. The recommended percentage of asset classes for a European investor could be something similar to the following:

20% European stocks
20% World stocks (not European)
20% REIT
20% European intermediate bonds
20% Commodities

If you are interested, we are going to propose specific ETFs (Exchange Traded Funds) to build it. For instance, for the bonds, a possible ETF could be iShares EUR Corp Bond ex-Financials 1-5 yr, which avoids banks and has a very decent diversification. For the commodites, a very popular ETF is Invesco DB Commodity Index Tracking Fund (ticker DBC). The other 3 will be tweeted during the week.

Buying ETFs is very simple, just find the ticker and buy it like shares from your broker.

What do we do?

Is Peter Shiff right and the recent drop in the markets is just the beginning? Or, on the other hand, is it just a healthy correction? We don’t know. But there are some facts that can help us:

1. Charts. The curve is very far from the mean. It usually reverses.
2. P/E. It is way above the historical average. We can expect to lower a bit.
3. Cash. The politicians won’t be able to resist the pressure and there will be more QE.
4. Timing. Individuals are awful timing the market. Even if we sell our positions now, probably we won’t find the right spot to reenter.

So, being sensible, a possible solution could be to have a balance portfolio (during the last month we’ve talked to many investors and some had more than 60% of their wealth in stocks, which is huge and very risky). Reduce the percentage of shares until you feel comfortable. Also, it could be a good idea to include some gold as insurance. Amanzingly gold is not overvalued.

In search of cashflow: perpetual bonds

A perpetual bond is a bond that only pays coupon, it will never return the principal. Some people call them "perps". As it has no maturity date, you can consider it equity.

There are 3 main considerations when we consider buying a perp:

1. How safe is the issuer. Government bonds from important countries should theoretically be safe (not so sure anymore). Also big reliable companies in defensive sectors. Beware of banks, though. Under the Basel-III requirement, an international capital standard, perpetual bonds or AT1 securities are more of a quasi-equity obligation. If an issuing bank incurs losses in a financial year, it cannot make coupon payment to its bondholders even if it has enough cash. Moreover, if the equity capital of the issuer falls below 6.125%, the entire investment of bondholders would be either written down or converted to equity.

2. Currency. You want to receive the payments in the strongest currency possible. Avoid emerging market currencies.

3. Interest rates. The price of these bonds strongly depends on interest rates. To calculate the price we just divide the annual coupon by a discount rate. For example, if a bond has a coupon of 8000 USD a year and we use a discount rate of 4%, the price of the bond should be 200000 USD. However if interest rates go up to 8%, the bond price is half the previous one.

It seems a very risky investment, but it doesn't have to be. If the coupon is high enough and the issuer is a reliable company that pays in dollars, in a few years the coupons will pay for the initial investment, and after that the investor and his inheritors  just receive some nice cashflow forever.

A little bit of macro. Countries

Which countries are cheaper to invest in the stock market? And sectors? Thanks to StarCapital we can rank countries and sectors. In the long term and in general, the lower the entry price, the higher the future returns. Check out the following:

We can see that Russia is extremely cheap, so it might make sense to place some small amount of our investing money in a Russian ETF, such as RSX. As you can see this ETF as biased towards the energy sector. Another option could be RSXJ (Small caps) and less oil and gas, obviously. 

Russia is a risky country and its currency has suffered a huge decline in the latest years, therefore only expert investors who know how to manage their risks should think of this market. But also, remember, that buying stocks of a "safe" country at desorbitan prices can be as risky, if not more, as Russia.

Our benchmarks

We track a portfolio that combines gold and stocks. But what are our benchmarks? 

Following the principles set in our book Against the Tide:

- For the gold part we have 1/3 GDX + 2/3 GLD (GDX tracks the big gold miners such as Barrick, Newmont or Goldcorp, and GLD the spot price of gold).

- For the shares, the benchmark is 1/2 DTN + 1/2 DOO (DTN is an ETF which gives exposure to U.S. large cap equity with high dividend excluding the financial sector, DOO is a similar one but focused on international stocks).

These benchmarks can be perfectly use to create the portfolio.

Tips on real estate investing

Where do we place our money nowadays? Stock market at all-time highs, bonds at 0% rate, cash in fiat currencies?

We could use gold but we don't get any cashflow from it. A good option might be investing in real estate, but we have to do it right.

First of all, we make money in real estate WHEN WE BUY, therefore that is the most important part of the process. Second, we need to focus on solving problems for the people, not on buying and renting apartments. Really, it changes our full perspective. And third, we have to understand the new trends in society and demographics.

Here, you can see a visual forecast of the future of the different real estate markets:

On-line shopping running wild and home working strongly increasing, what can we expect from buying offices or malls? On the other hand, with an aging population, nursing homes and hospitals have a very bright future.

If we professionalize our buying and renting process, managing real estate can become a very lucrative part of our portfolio.

Contentos con la evolución de la cartera

A veces una imagen vale más que mil palabras... La línea negra refleja la evolución de la cartera que utilizamos como benchmark o comparativa para el portfolio expuesto en nuestro libro A Contracorriente. Como ya conocen nuestros lectores, el aspecto fundamental y diferencial de nuestra cartera es evitar las grandes caídas mientras superamos la inflación. En este sentido, este año hemos podido comprobar la eficiencia de nuestro sistema en dos días especiales, el Brexit y la victoria de Trump, en ambos casos con gran éxito.

Hay muchas nubes en el horizonte y se necesita máxima habilidad, lo cual cual básicamente quiere decir que hay que saber gestionar el miedo.

Les deseamos desde SimplyNoRisk un feliz 2017 lleno de salud y suerte. Si desean seguirnos en Twitter, nuestra cuenta es @simplynorisk