I have touched on the idea of a counter strategy a few times, writes Roger Nusbaum. Very simply, a counter strategy is a hedge against being wrong. As an example if you think big cap is the place to be you would have some exposure to small cap in case you are wrong about big cap.
The way I implement the concept is by owning a few things that I expect to go down while the rest of the portfolio is hopefully going up. Most clients have exposure to gold and some sort of inverse index fund. I also use a foreign bond CEF that is a play on the dollar getting weaker which may or may not be a counter strategy.
I am no gold bug but when bad things happen in the world gold goes up in price. I want the inverse index fund to go down because that means everything else, collectively, is going up. It can be tough to explain to clients why an inverse index fund is down 18% (or whatever) but it will help if something bad happens in the market. This ties into focusing on the portfolio and not the components. I was just interview on this topic last week. If it gets published I will post the link.
If you have a diversified portfolio, there is no way everything will be working at the same time. In fact if everything is working you probably aren't as diversified as you think. Since I don't believe everything can or should work at once it makes owning an inverse index fund easier. Some will get it and some will not. But if less volatility than the market is the goal ( and that usually is the goal for people that hire a separate account manager) then owning an inverse index fund gives you a very good shot of being down less than the market when the market does go down. In an environment like we have now a high yield for the portfolio can help offset the drag created by inverse index funds in an up market.
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