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Bullish and Bearish: Using Hedged Strategies for an Uncertain World

Louis Abel, Managing Director, First Foundation Advisors

April 20, 2010

Through all the uncertainty and risk in today's market there's a way to play it evenly by using hedged strategies. By this I mean investing in funds that take both bullish and bearish positions, which allows for participation in gains whether the market goes up or down. At First Foundation we've identified several ways to do this. Many clients have found this an ideal way to stay in the market without exposing themselves too much to a certain asset class.

Historically, diversification has been the first line of defense against risk. The old adage "don't put all your eggs in one basket" is as relevant as ever, especially given the uncertain world we're in. Even my five-year old son, on an Easter egg hunt, knows not put all his eggs in one basket! Diversification has historically provided investors with some protection for the simple reason that various asset classes are not perfectly correlated. Said more plainly, when stocks "zig", bonds tend to "zag", when Treasury bonds "zig", high yield bonds often "zag", and so on.

But what we've discovered is that in times of crisis - especially during periods of severe stress like 2008 - is that diversification doesn't always work that well. When correlations among the various asset classes begin to converge toward one as they did in 2008 it provides few places of safety. This is one of the key lessons taken from the crisis.

As a remedy to broad market declines we have identified several ways to provide hedged exposure. One way is by investing in a hedge fund. While an important vehicle for some investors, they also have drawbacks - such as less liquidity than traditional investments like stocks and bonds. Hedge funds can be appropriate for investors needing less liquidity, but for investors who demand it there are also certain mutual funds that utilize hedge fund-like strategies. The beauty of mutual funds is that unlike actual hedge funds they are completely liquid.

While the future of the market always remains unknown, I invite investors to consider these hedged strategies as something that might make sense for them.

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