Forward or reverse? Finding the right gear for any market direction | BetaShares

Forward or reverse? Finding the right gear for any market direction

BY Dan Annan | 6 November 2019
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In many of my conversations, I come across professionals who express FOMO (Fear Of Missing Out) and yet still they sit on the sidelines when it comes to investing in the market. It seems that everyone these days is nervous about market valuations, and top of mind for many is how much more upside there is in the sharemarkets.

While sharemarkets generally have been quite volatile for a while now (think U.S. – China trade war), they are currently at or near all-time highs. Indices have been trending upwards for almost a decade, and from 2013 (which some will argue was the start of the bull market post GFC) to 31 October 2019, the MSCI World, S&P 500 and the S&P/ASX 200 indices are up 17.3% p.a., 21.1% p.a. and 10.1% p.a. respectively, in AUD terms.

Source: Bloomberg. Past performance is not indicative of future performance.

It has been profitable to be bullish during this time period. However, even the ‘permabull’ (the permanently bullish investor) may be skittish about how much longer this run will last – understandably so as market valuations look expensive, albeit in a low interest rate environment.

Some believe we are in a secular bull market that has further to run, while others believe markets are overvalued, and we are thus headed towards a secular bear market. What’s an investor to do?

While we at BetaShares have no crystal ball, we do offer plenty of options for whichever direction you think the market is headed. For almost a decade, BetaShares has been building out investment options with the Australian investor in mind, and has developed investment tools for different types of investors and market cycles. So, with BetaShares funds, both the Bull and the Bear have options.

It should be noted that the selection of funds discussed below is more relevant for investors with strong convictions about the outlook for sharemarkets i.e.  investors who want to retain exposure to the sharemarket in some form and who have a relatively high tolerance for risk.

The Bull

BetaShares has two funds that deliver geared performance to the U.S. and Australian sharemarkets, the Geared Australian Equity Fund (hedge fund) (ASX: GEAR) and the Geared U.S. Equity Fund – Currency Hedged (hedge fund) (ASX: GGUS).

If an investor currently has broad exposure to the Australian or U.S. markets, and feels they have had a good run (which, depending on their investment time frame, they probably have!), a potential strategy they could consider involves taking a portion of their winnings and allocating it to the geared products to effectively maintain their sharemarket exposure.

The gearing ratio of both funds is managed between 50% and 65%, meaning that a 1% increase in the relevant index on a given day should result in an increase in the value of the fund of approximately 2% – 2.75%. There should be a converse outcome if there is instead a 1% decrease in the relevant index on a given day. An investor can therefore maintain a desired level of exposure to the index with far less capital than an ungeared investment, and without risk of margin calls, unlike some other ways of getting geared share exposure.

It is essential to note that gearing magnifies both gains and losses – if the market falls, GEAR and GGUS can be expected to produce magnified losses. Geared funds are therefore more volatile than ungeared funds and may not be a suitable strategy for all investors.

To illustrate the effect of gearing, the chart below shows the one-year return to 31 October 2019 for GEAR against the performance of the S&P/ASX 200 Index.

Source: Bloomberg. Past performance is not an indicative of future performance.

For the 12 months to 31 October 2019, GEAR returned 37.1% against a rise of 19.2% in the S&P/ASX 200.

The Bear

For the bearish investor looking for portfolio insurance, or indeed to profit from a falling sharemarket, BetaShares offers Australian and US short funds:

BEAR provides short exposure to the broad Australian market. BBOZ and BBUS provide magnified short exposure to the Australian and US markets respectively, with a 1% fall in the relevant index on any given day generally expected to deliver a 2.0% – 2.75% increase in the value of the fund (and vice versa).

These funds give investors a simple and accessible way to obtain short exposure to the Australian and US core equity markets, and can be used to hedge portfolios against falling markets. If an investor holds a broad sharemarket exposure, a fall in the value of their portfolio should be at least partially offset (depending on the size and gearing of the short fund holding) by an increase in value of the short fund.

These funds offer investors certain benefits over alternative methods of gaining short exposure, such as futures or CFDs:

  • easier to trade and administer
  • require no margin loans
  • involve no risk of margin calls for investors
  • limit downside to the capital invested.

To illustrate how the short funds can be used in a portfolio, in the wake of last year’s market volatility in October (‘Shocktober’) BEAR, BBOZ and BBUS played defence for investors looking to hedge their Australian and U.S. equities exposures.

The chart below shows the performance of BEAR and BBOZ against the S&P/ASX 200 Index over that period.

Source: Bloomberg. Past performance is not an indicator of future performance.

Summary

There are mixed views around the outlook for equity markets. Valuations are arguably high, and central banks globally are starting to engage in monetary policy in anticipation of potential market slowdowns. Whatever your view, BetaShares has an exchange-traded solution to help you take action.

 


Please note: The Bear funds’ strategies of seeking returns that are negatively correlated to market returns is the opposite of most managed funds. Also, gearing magnifies gains and losses and may not be a suitable strategy for all investors. Investors in geared strategies should be willing to accept higher levels of investment volatility and potentially large moves (both up and down) in the value of their investment. Geared investments involve significantly higher risk than non-geared investments. Investors should seek professional financial advice before investing, and monitor their investment actively. An investment in any of the Funds should only be considered as a component of an investor’s overall portfolio. The Funds are actively managed and do not track a published benchmark.

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