Investors told to seek protection

Equity investors need to protect against downside risk to get the best returns from the volatile asset class, financial advisers have been told.

Wednesday, March 26th 2014, 5:55AM

by Niko Kloeten

Speaking at the Meet the Managers event in Auckland, Perennial Investment Partners portfolio manager Dan Bosscher said such protection didn’t need to be expensive and could make a significant difference to investor returns.

Perennial is about to launch a new Wealth Defender Fund, which uses "dynamic risk management" incorporating regularly adjusted levels of insurance cover and cash holdings to protect against drops in the equity market.

“If we use simple tools to manage risk we can get timing but we can’t use a set and forget approach,” Bosscher said.

Data from Perennial showed that over a 30-year period, time in the market could turn an initial investment of $1000 into just under $23,000, an 11% compounded return.

Being three months early on market peaks and troughs would result in $86,613 on an annual return of 16%, while being three months late would achieve $90,804 over that period. Timing the market perfectly would give the investor $262,370 on a 20.4% annual return.

“We’re not trying to pick the tops and the bottoms; the point of this is to demonstrate the difference between doing something and doing nothing,” Bosscher said.

Phil Boustridge, director of strategy at Pengana Capital, said over the past 40 years the MSCI World Index had been in drawdown 70% of the time, highlighting the risks of a long-only approach.

Boustridge said a "market neutral" approach, such as that used by the Pengana Australasian Equities Market Neutral Fund, was one way of reducing overall portfolio risk.

This strategy, which typically incorporates some form of hedging, results in funds that have little to no correlation, and sometimes even a negative correlation, to equity indices.

“When you get a shock everything tends to go to [a correlation of] one. You lose that diversification benefit when you need it most.”

Niko Kloeten can be contacted at niko@goodreturns.co.nz

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