Playing Defense in your International Positions

by Wayne Ferbert on February 28th, 2012

PIMCO founder Bill Gross has put out his March 2012 Outlook. His monthly investment outlook newsletter is probably the most read free investment newsletter in the world (find it here at this link if you want to read it).

The March outlook is titled: Defense. It is all about getting more defensive in your portfolio by moving to a more ‘risk-off’ stance. In particular, Gross thinks that Global markets still carry tremendous systemic risk. Amen Bill! Hallelujah! The guys at Buy And Hedge get all warm and fuzzy when people talk about playing defense – after all, Buy & Hedge is all about defensive investing.

In Bill Gross’ case, however, the investment hypothesis is more about reducing your risk assets – like emerging markets and international exposure. Meanwhile, at Buy And Hedge, we like to always have risk assets in our portfolio. When we are hedged, the risk assets are not quite as risky.

But there are times in the Buy And Hedge approach to get more defensive. In our case, when we want to get more defensive, we tighten up our hedges. What does that mean? It means we move our floors on our positions up. We move up the prices that control where our losses stop (ie, where our protection begins).

Let’s look at emerging markets and developed international markets since Mr. Gross thinks these should be under-weight. You might use two very popular ETFs that offer options for emerging markets and international developed: the EEM & EFA, respectively. We use them as part of our asset allocation. These ETFs have healthy and reliable options markets.

Both of these two ETFs have had very nice market runs since hitting their bottoms in December. The EEM is up 20% and the EFA is up 15%. Of course, a good portion of this rally can be attributed to the fact that these ETFs were so beat up in 2011 because of the global credit crisis. These two ETFs are still well off of their 52 week highs, after all.

So, if you want to consider getting more defensive in these positions, then think about resetting your hedges to higher protection levels. Look to roll out to a further month – with high protection in your strike price. In the EEM, we have been resetting many hedges to closer to $40. And in the EFA, we have been resetting to around $48-$50 strikes.

If you have enjoyed the run-up in these assets, resetting the hedge is like locking in some of the gains. Your earlier protection levels have probably lost some value – but these new higher levels will protect you if you think Bill Gross is right.

Personally, I am not sure that Bill Gross’ outlook is right. But we are always looking for room to re-set hedges when the market runs up. The rally of the last three months certainly qualifies. And if resetting the hedges on Emerging markets means that me and Bill Gross agree – then I am in good company!


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