The prospect of ongoing volatility in global markets could encourage advisers to consider risk mitigation strategies to protect the long-term holdings of clients.

A Reuters poll of 150 equity strategists in August found most expect global shares to record modest gains in the coming months. Nonetheless, there is also a prevailing mood of caution in the market-at-large. “Easing inflation pressures, central banks moving to cut rates and prospects for stronger growth in 2025-26 should make for reasonable investment returns over 2024-25,” AMP Investments Chief Economist, Shane Oliver, wrote on August 16.

“However, with a high risk of recession, poor valuations and significant geopolitical risks particularly around the US election, the next 12 months are likely to be more constrained and rougher compared to 2023-24 and there is a high risk of a further correction in the next few months,” Oliver said.

It is a view mirrored by other analysts as they assess the immediate market outlook.

“Panic is not warranted but caution is recommended. A market sell off usually helps to moderate expectations and valuations, however, we believe we are in mid-to-late cycle conditions and market concentration combined with still above average valuations make equities vulnerable in the near term,” Fidelity International analysts recently said.

Several strategies and products offer the potential for advisers to offset this risk for clients, depending on the objectives and circumstances of each individual.

Options strategies

In a market sitting around record highs, several options strategies can help advisers manage risk on behalf of clients.

“A great example is Commonwealth Bank (ASX:CBA). Selling CBA at its current level may cause a capital gain tax problem for investors. Advisers could instead consider a trade known as a collar,” said Haydn Froggatt from Fairway Capital Pty Ltd, a derivatives-focused income fund.

“A collar is a strategy that involves selling a covered call option and at the same time purchasing a put option. The idea is the income received from selling the covered call helps fund the purchase of the put option,” he said.

This strategy will cap any further upside in the stock to the strike price of the sold call option. The put option provides downside insurance. 

Froggatt said that many options strategies might appear high risk but are, in fact, lower risk than an outright stock purchase. He gave the example of BHP (ASX: BHP).

“Instead of purchasing 5,000 BHP shares at $41 [in August], an investor could sell 50 BHP October $40.50 puts for about $1or a net $5000.

“If the BHP share price is below $40.50 in October then the puts will be exercised and the stock purchased for $40.50. But when you include the options premium. the net purchase price will fall to $39.50. So the options strategy has allowed an investor to buy BHP at $1.50 below [the August price].”

Minimum volatility ETFs

There are several exchange traded funds (ETFs) listed locally that seek to reduce risk by investing in portfolios which may lose less than the overall market during downturns.

iShares’ MSCI World ex Australia Minimum Volatility ETF (ASX: WVOL), for example, tracks the MSCI World ex Australia Minimum Volatility (AUD) Index. The index is designed to measure the performance of developed market equities that, in the aggregate, have lower volatility characteristics relative to developed markets as a whole.

The fund’s top holdings include telco T Mobile US, pharmaceutical company Johnson & Johnson, Berkshire Hathaway and health care company Merck & Co. It returned 15.66% in the year to July 31 and 6.79% in the five years to the same date.

Vanguard’s Global Minimum Volatility Active ETF (ASX: VMIN) instead has a portfolio of global shares that includes Australian companies. It is an active fund that aims to provide long-term capital appreciation with lower volatility than the FTSE Global All Cap Index (AUD Hedged). Close to 60% of its holdings are in US companies, following by Japan (10.4%), the United Kingdon (6.9%) and Australia (3.6%).

Blackrock also offers the iShares Edge MSCI Australia Minimum Volatility ETF (ASX: MVOL), which tracks the MSCI Australia IMI Select Minimum Volatility (AUD) Index.

Inverse ETFs

Advisers and investors with a particularly bearish outlook – and an understanding of short selling – might consider using inverse ETFs to profit from falling markets. 

Betashares – which operate three inverse ETFs – suggests this style of investment should be monitored daily. 

Its Australian Equities Bear Hedge Fund (ASX: BEAR) expects to generate a gain when the S&P/ASX200 Accumulation Index falls on a given day, and a loss when it rises. A 1% fall in the Australian sharemarket on any day can generally be expected to deliver a 0.9% to 1.1% increase in the value of the fund.

Betashares’ Australian Equities Strong Bear Hedge Fund (ASX: BBOZ) takes a higher octane approach by offering geared short exposure to the local sharemarket. A 1% fall in the Australian sharemarket on a given day can generally be expected to deliver a 2% to 2.75% increase in the value of the fund (and a corresponding decrease in value if the local market rises).

Other inverse ETFs have the potential benefit of allowing investors to protect a portfolio of US shares from market declines without having to sell shares.

Betashares US Equities Strong Bear Hedge Fund – Currency Hedged (ASX: BBUS), again uses gearing and is linked to the performance of the S&P500 Total Return Index. 

Similarly, the Global X Ultra Short Nasdaq 100 Complex ETF (ASX: SNAS) aims to provide geared returns that are negatively related to the returns of the Nasdaq 100 index. Unsurprisingly, it hasn’t had a great run in the AI boom – its total return -36.5% in the year to the year to July 31.