17 Jan 2019

Protecting the downside

Predicting the market movements, especially in the near-term is difficult. Markets might go down further from here, but they might also bounce back strongly. We, and in our opinion no-one else either no matter how confident they sound, can know for sure. We certainly understand that big market drops can be very unpleasant. But it is important to remember that, in our opinion, successful investing is a long-term game. These events can be wonderful opportunities to create long term wealth, but to benefit from them you need to ensure that you don’t suffer from permanent loss of capital.

We can give you some examples of things that we have done to reduce the impact on our portfolios in the event of a big market downturn or crash. In the 5 Oceans Fund we have invested in a fund that specialises in downside protection. It does this by investing in derivatives that slowly decrease in value in benign markets but go up substantially in big market downturns. Roughly 5% of the portfolio is in this fund. This fund's investment objective is to return several hundreds of percent in the event of a big market downturn. We also use asset managers with more flexibility than traditional balanced funds, such as the Ranger Fund.

In the Ranger Fund we have invested in our own similar derivatives portfolio. Roughly 2% of the fund is invested in put options which we would expect to return several hundreds of percent in a big market downturn. The objective of these investments is to minimise the negative returns in those downturns and then utilise the cash generated to make investments at close to the market bottom. While negative, the NZX and ASX price movements, to date, have not been particularly extreme or volatile. The option portfolio is there to cover more extreme events. We are also holding roughly 34% of the fund in cash and short-term debt instruments.

Most importantly, we have invested in companies with, in our opinion, great long-term prospects. These market events come and go, but good companies remain and often prosper after them. They prosper because weaker competitors often fail or are taken over, reducing the level of competition when markets normalise.

There are always great long-term investment opportunities and Mr Market often puts them on sale in these times. We recently increased our investment in Kogan in Ranger Fund and are seeing some interesting Value opportunities that we are working on. In our opinion, given the protection we have in place, and the potential for our existing investments, our funds are well positioned to take advantage of this market volatility.