- You can create and manage a profitable long/short stock portfolio to mitigate market risk in a volatile investing world.
- You don't need to be a millionaire to do it.
- You will have to do a bit of work to set it up, and then keep an eye on it on a regular basis-especially on your shorts (not my shorts… your shorts, merci!)
- In Part One, I will lay bare to you ze basics. In Part Two, I will hold your hand as I help you set up your portfolio. In Part Three, I will lie back while you launch, and I will gauge your performance.
I am Desiree, ze only woman in Sleepless in ze Alps who is not Swiss. I am totally French. But don't get any ideas-we are here to talk business, and not ze "fooling around" kind of business. (Pardon ze accent, but my lips, they are not used to ze ugly English. Ugh.)
Here I am (above) in my new Lamborghini, which I can afford because of my long/short portfolio. Nice lines, n'est-ce pas?
As global equity markets zigzag along with punch-drunk central bankers in ze driver's seat, some of you may want to hedge your bets in case a wheel comes off and ze markets crash through ze guard rail and head off ze cliff. In your head, you know that if you "stay ze course," markets will revert to their mean after a month, a year-ten years? In your heart, you are skeptical and fearful. And in your gut? Oh, merde!
What can you do? Is there any alternative to losing ze money?
Do not fret, mon amour. Do not lose any more of ze sleep over zis. Here in my series of articles, I will show you everything…
One of ze best ways to hedge your equity assets is by setting up a Long/Short portfolio. What exactly IS a long/short portfolio, and why and how does a good one accomplish what it sets out to do? Read on, mon coeur…
This particular chien (above) is "Long Only." He is Swiss-German, and if you bring him bratwurst he will follow you anywhere).
Your long/short portfolio is composed of long positions in stocks that you expect to appreciate and short positions in stocks that you expect to decline. Two "profit legs." Ze aim is to minimize market exposure, while you profit from stock gains in ze long positions and price declines in ze short positions. This works on a net basis as long as ze long positions generate more profit than ze short positions, or ze other way around, depending on market conditions. Each one of ze profit legs always has to work better than ze other all ze time.
My legs (above) are not ze "profit legs."
Zis long/short idea is popular with hedge funds, many of which also employ a market-neutral strategy. Market-neutral is where ze dollar amounts of ze long and short positions are equal. Long/short strategies aim to vary their long and short stock exposures across industries, taking advantage of undervalued and overvalued opportunities. Market-neutral strategies focus on making concentrated bets based on pricing discrepancies, trying to achieve a zero beta against appropriate market indices to hedge out systematic risk. You got zat?
(It's right here that I have to say that a long/short strategy is NOT for passive investors, especially retirees. I do NOT recommend a long/short portfolio unless you want to keep your eyes on it on a steady basis. It's ze "short" leg that won't let go of your attention. Long positions in equities are on automatic pilot-calm, sedate-Zen. Short positions are demanding, manic, and teeth-grinding. Buy and Hold is smart and sane and it works over the long term. But that's not what this is about. In zis article I am addressing ze stock jockeys-all you gun-slinging, steely-eyed, macho traders swinging your ten-inch laptops. Zut!)
In ze portfolio we are going to build, we will be using equities only-no hard-to-understand options, none of zose truly awful inverse or alternate ETFs, no other gimmicks. Just ze good old stocks. And success here isn't a lock, not a definite. Ze process is doable, but you have to do some work, some thinking, and have some money. Like at least a "honey" (zat's one hundred thousand dollars to all you bad boy retail traders).
Why so much money? Ouah, this is 2016! If you live in the US or the EU or in most developed countries, that's no longer a lot of money for this exercise, and if that's your whole cassoulet, a solid hunk of that should be held in ready cash, not in a portfolio like we are going to build.
In fact, if you are in or entering retirement, I hope you're reading zis article just for fun (or maybe ze pictures?) and ze hard-earned money of your life's sweat should be in one or two inexpensive, passively-managed, global stock and bond index funds, rebalanced once a year forever. Zat's all you need. Not zis.
But, eef you insist…
Back to ze story. Now, put your honey (or whatever amount you want to invest) into a deeply discounted brokerage account and you're ready to start building your long/short portfolio. "Deeply discounted" is required because you're going to do some trading here. You will be adding stocks, subtracting stocks, rebalancing. Very macho. (Go ahead cowboy, you can call yourself a "hedge fund" now if you like…zounds good, eh? But remember: ze difference between you and a "hedge fund" is that "hedge funds" have ze "customers." You don't. Quel dommage…)
Now I am going to suggest a discount broker, but rest assured, I am not getting any points or commissions from this little bit of ze shill. Use your own platform if you like, but this one is set up beautifully for this exercise: Interactive Brokers.
Interactive Brokers executive offices in Connecticut, USA
Oops! Zat is ze wrong picture…
Interactive Brokers executive offices in Connecticut, USA
(Sorry about zat. Ze first picture was where Clarissa's new boyfriend lives, zat parasite. Well. What do you expect?)
You are groaning now. Interactive Brokers? Ugh. IB has a lot of drawbacks, especially in terms of un-ease of use, Neanderthal-like service, and a confusing, goopy learning curve. But if I were a retail customer like you, I'd make ze effort and learn to use their Mosaic platform. For a long/short portfolio it is magnifique!
And their $1 commissions on stock trades can't be beat, their surprising dark pool depth is impressive (more on zat in Part Two), and you can short a whole lot of issues with ease on their truly immense, globe-straddling platform. If you are not in love with IB (a lot of people aren't) just choose your own discount broker. This will work on any deep platform, just watch out for trading costs, they matter.
Hokay, you did all of ze above? All set to begin portfolio building?
Well, I am not. I have a date. And I am late. Zo you will just have to wait. For Part Two.
In Part Two (coming shortly) I will hold your hand as we construct your portfolio together, massage it to perfection, and in Part Three, you will launch. Voila!
Additional disclosure: Additional Disclosure. I have a bit of trouble with ze English, as you can see. Ze goood news is I am not losing much of ze sleep over it. You shouldn't either.