A day like today in the market can make it painful to look at your mutual fund holdings. For example, of the Fidelity Select funds that we track, they were all down anywhere from 0.41% to 3.24% It’s clear that in order to manage mutual fund portfolio risk, diversification alone will not do much on a day like today, when everything is down. (This is an example of what is sometimes referred to as negative co-variance, where market instruments like mutual funds and ETFs tend to be uncorrelated on the upside, but when bad news strikes, they have a greater degree of correlation (i.e. they all go down at the same time).

This is why we’ve started tracking a hedged mutual fund portfolio. In this case, we are shooting for a true hedge, where we hold 20% of the total potfolio in the Proshares ETF SDS, which is a leveraged bear fund that tracks the S&P 500, so for a day like today, where the S&P500 was down about 2.3%, SDS was up about 4.6%. So our hedged portfolio was actually up about 0.3% today. Now, of course a hedge will usually cost some return over time, and we expect that the hedged portfolio will not have as robust a return over time, but we do expect that it will have a significantly lower drawdown over time. For example, the current drawdown is about 0.37%, compared to over 3% for our composite portfolio. (Current performance can always be found here. The hedged portfolio is labelled FNDZ6)

So, if you are really concerned about reducing drawdowns and capital preservation, take a look at hedging your mutual fund portfolio. You can always learn more about the details of hedging your mutual fund portfolio by signing up for our newsletter (the signup box is on the right side of the page.)