Preparing for a market correction – hedge or diversify?

The bulls and bears are out in force, divided over the prospect of a market correction in the near future, but is it wise to hedge equity exposure or is good old-fashioned diversification the way to go?

Preparing for a market correction – hedge or diversify?

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Indeed, 7IM recently upped gold exposure across its funds to the highest ever level after “fastening its seatbelts” in anticipation of a potential market correction.

In terms of volatility, Sleep says he accepts the VIX is currently relatively low, but this does not give an accurate impression of the cost of options because the quoted VIX is not investable as it is a spot price and therefore not tradable – and buying any option is more expensive than the spot suggests. 

For instance, he notes, the spot is currently at 12, whereas the September VIX future is 13.1 and the March 2018 future is 16.5.

Whether or not investors believe a correction is imminent, it would not hurt to avoid complacency and be aware of the options available to make the portfolio resilient to shocks.

As GMO’s Matt Kadnar and James Montier wrote in a recent paper: “It is remarkably easy to assume that the recent past should continue indefinitely, but it is an extremely dangerous assumption when it comes to asset markets.

“Particularly expensive ones, as the S&P 500 appears to be.”