2 September 2011

Hedging and Ice Cream

Hedging your investments has long been possible for professional investors. But there are also possibilities for retail investors, too.

What are we talking about? Normally, if an investment goes down in value the investor will lose out - on paper at least. But if you can find an investment which goes up when something else goes down, you can (at least) reduce your loss.

Here's a simple example (although you might say it's more about diversification than hedging, but it illustrates the point)... If you invest in an ice cream manufacturer you will do well on sunny days but badly on wet days. So why not "hedge" your investment by also investing in an umbrella manufacturer. That way, one part of your portfolio increases in value whatever the weather!

Professional investors - including discretionary managers who look after retail clients' money - will hedge by doing things like buying and selling "options". That way they profit if an index like the FTSE 100 goes down, reducing the overall loss in the portfolio.

But you can also make use of structured products to do something similar. By picking products which give different returns for different outcomes (the FTSE goes up a lot, up a bit, down a bit, etc.) you can secure some growth whatever the markets do (within certain constraints).

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