All About Hedging
AMG Wealth Advisors
Hedging to improve investment outcomes is a key component of our philosophy. We typically discuss risk and return and how one impacts the other. In this article, however, the focus will be exclusively on risk and how it can be managed and even reduced, through effective hedging techniques.
What is a Hedge?
Simply put, a hedge is a form of protection, or defense, against losses. Much like how a homeowner’s insurance policy can protect the asset from the financial risk of flooding, the use of hedges can reduce potential risk to investment portfolios. When properly implemented, hedges allow investors to remain steadfast in their investment strategy during times of market volatility.
Loss Aversion and Investor Behavior
Loss aversion is a concept in behavioral economics that describes a common cognitive bias where investors feel more psychological pain when sustaining losses than they feel psychological reward when capturing gains. This is a very important concept to understand, as emotional responses to market volatility can lead to impulsive reactions that can be detrimental to long-term investment outcomes. We strive to ensure our clients understand the details of their investment strategy, as we believe adequate knowledge equates to confidence in financial plans and investment objectives.
Hedges have an important role when it comes to loss aversion. They are implemented using equity options in order to minimize losses during times of market volatility and avoid these impulsive reactions. Remaining invested is crucial, so our portfolios are able to capture gains when markets are outperforming.
Hedging in our Portfolios
We use hedging not only to minimize loss aversion but also to optimize our investment allocations for maximum returns. Properly implemented hedges give us the freedom to increase allocations to assets with higher return potential, such as an increased exposure to growth stocks or technology stocks.
The focus of our investment strategy is centered around reducing losses and controlling the impulsive reactions that come with loss aversion. Our belief is that remaining invested during periods of heightened market volatility is the biggest factor in being able to maximize investment gains. A focus on financial planning and long-term investment objectives will always remain paramount, and the prudent use of hedges naturally fosters this rational investor behavior.
Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any securities or to advise on the use or suitability of The AMG Managed Portfolio Series or any of the underlying securities in isolation. Information specific to the underlying securities making up the portfolios can be found in the Funds’ prospectuses. Please carefully read the prospectus before making an investment decision.
This commentary offers generalized research, not personalized investment advice. It is for informational purposes only and does not constitute a complete description of our investment services or performance. Nothing on this fact sheet should be interpreted to state or imply that past results are an indication of future investment returns. All investments involve risk and unless otherwise stated, are not guaranteed. Be sure to consult with an investment & tax professional before implementing any investment strategy.
Investing involves risk. Principal loss is possible. Investing in ETFs is subject to additional risks that do not apply to conventional mutual funds, including the risks that the market price of the shares may trade at a discount to its net asset value(“NAV), an active secondary market may not develop or be maintained, or trading may be halted by the exchange in which they trade, which may impact a fund’s ability to sell its shares. Shares of any ETF are bought and sold at Market Price (not NAV) and are not individually redeemed from the fund. Brokerage commissions will reduce returns. Market returns are based on the midpoint of the bid/ask spread at 4:00pm Eastern Time (when NAV is normally determined for most ETFs), and do not represent the returns you would receive if you traded shares at other times. Diversification is not a guarantee of performance and may not protect against loss of investment principal.