2024-07-26 19:56:39 ET
Summary
- Hedge funds used to focus on hedging risks in investments, but hedges are now most commonly used to hype returns.
- Traditional hedging was done using put and call options which are expensive and not always effective. A few other strategies get similar results.
- An investor should probably only hedge against major crashes with underlying economic causes, which may impact all or a part of the market for some time.
- The current market is divided between popular large-cap growth stocks, which are very expensive, and value stocks, which are cheap. Fixed income also provides good value.
When I was a youngster hedge funds actually hedged things. If the fund operator owned a portfolio with high risk but the possibility of producing spectacular returns, the decision to hedge your bet was undertaken to reduce risk while holding on to the bulk of the large gains. This was often done by trying to buy the best firm in an industry while selling short the worst, often by buying put options. Sometimes this took the approach of buying or selling options on an entire industry likely to offset risks in a major bet on a single stock. It was like buying insurance against potential ruin if the major bet does poorly. That was yesterday. Most modern hedge funds are mainly out to ramp up profits by doing things like borrowing in a currency with low interest rates while focusing on a handful of favorite stocks. Warren Buffett actually did exactly the same sort of carry trade by borrowing in yen at .5% interest to pay for a large position in five huge Japanese trading companies. So far this has worked out brilliantly for Berkshire Hathaway ( BRK.A )( BRK.B ) as Buffett has trounced other investors in Japan who did not hedge against exposure to the yen. ...
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For further details see:
To Hedge Or Not To Hedge, That Is The Question