The global bond market was on high alert well before the yield on U.S. five to thirty-year Treasuries topped 5 per cent this week.
Now the global stock market is taking notice and that could have a more immediate impact on your retirement portfolio.
You can’t stop a tidal wave but there are ways to protect vulnerable holdings without crimping overall portfolio growth.
Here are five hedges that could fit into your strategy:
1. Equity diversification
Equity markets will likely shrug off the bond warning this time and continue a strong year with the benchmark S&P 500 and S&P/TSX both up about 12 per cent.
But they will continue to be under pressure as long as inflation keeps pushing interest rates up.
Spreading your investments across sectors and geographic regions can limit concentrated risk and expose your portfolio to a world of opportunity.
While it might seem equity markets move in tandem, some sectors and regions often move in different directions at different times.
As examples, the information technology (IT) boom has pushed the S&P 500 technology index up by 28 per cent so far this year while financial services have traded flat.
2. Shift to fixed income
While high interest rates are generally bad for equities, they are good for fixed income. Not fixed income funds, but rather fixed income held to maturity.
Equities that you deem vulnerable can be shifted to a fixed income portfolio of investment grade bonds and guaranteed investment certificates, which can yield over 4 per cent annually according to ratehub.ca.
That might not hit your overall return target after inflation, but it’s money in the bank.
The portion of the entire portfolio that should be allocated to fixed income depends on your risk level, age, and how soon you need cash in retirement.
3. Writing covered calls
The derivative or options market also presents opportunity to generate safe income by writing covered calls on lackluster stocks you already own.
The writer, or seller, of a call gives the buyer the legal right - but not the obligation - to buy shares in the underlying stock at a set price (strike price) any time on or before a set date.
If the stock rises above the strike price the owner will likely be forced to sell at that higher price but if it remains below it, the writer keeps the stock, any dividend it generates and a premium paid by the buyer.
Writing covered calls is also permitted in registered retirement savings plans (RRSP) and tax free savings accounts (TFSA).
4. Short selling
If you think parts of the market are overheated, another option is a short selling strategy designed to balance a ‘long’ portfolio to generate returns when equity markets go down.
Short selling involves borrowing securities, selling them on the open market, and buying them back at a future date (ideally at a lower price).
Short selling directly into the market is fraught with risk and generally for experienced traders, but there are several long/short mutual funds that will do the balancing for you - for a fee.
Investors can also take short positions through ‘bear’ exchange traded funds (ETFs) for just about any index, commodity or sector.
5. Trailing stop-loss
Placing conditional orders on equities in your portfolio, such as a trailing stop-loss, can automatically lock in gains as the investment rises in value and limit losses if they plunge.
A basic stop-loss is a pre-set price below the current price that will automatically trigger a sell order if it falls to that level. For example, if a stock purchased at $10 has a stop-loss placed at $8, losses will be capped at $2 per share.
A trailing-stop resets the stop as the stock rises. In other words, if a stock rises the trigger to sell moves up in proportion to the real-time price, like a moving stop-loss. In addition to locking in gains, a trailing stop locks in bigger gains as the stock rises.
You can execute most hedge strategies through an automatic broker or pay a fee with a qualified advisor.
