From the Dealing Desk: Portfolio Hedging with CFDs

With economic and geopolitical events taking place around the world that are beyond our control and extraordinary by nature, we have been fielding many questions from clients about how they can temporarily immunise their portfolio returns from what they might feel is a period of likely volatility.

Naturally a client can sell his or her entire portfolio in order eliminate exposure to market returns for a desired period of time; however, depending on the size of a portfolio, this can become a very expensive exercise, while occasionally impractical due to options positions, and deregistering your holdings temporarily can spell a whole lot of junk mail from the public companies you own part of and the registries that handle your ownership details. In addition, placing a hedge over your portfolio means that you do not need to realise profits/losses on your share positions prematurely; this can make a huge difference, depending on your tax situation.

For this reason, today’s From the Dealing Desk will instruct you on how you can implement a strategy that aims to ‘hedge’ your portfolio by eliminating negative and positive returns for any length of time that you desire.

Implementing a perfect hedge

A perfect hedge completely neutralises positive and negative returns, but attracts commissions on share transactions.

The most effective way you can implement a hedge is to employ an opposing trade to each of the securities you hold with the identical volume as your holding. So if you own 100 BHP shares, you ‘short sell’ 100 BHP share CFDs, simply by selling them without holding them in the first place. If the BHP holding falls on your share trading account, it will rise in your CFD account by the same factor. If BHP pays a dividend during this period, your CFD account will pay out that dividend, so all moves will be countered.

Click on the image at the top right of this page to see what a perfectly-hedged portfolio scenario might look like.

There are four factors to take account of when implementing this type of hedge:

Underlying portfolio profit and loss: Zero
Brokerage cost: 0.10% of portfolio, when using Rivkin Securities
Net CFD income from short position: 1.75% p/a, when using Rivkin Securities
Franking credits: While your underlying portfolio will pay you franking credits, your CFD account won’t debit franking credits, paying out just the dividend alone. This will be a net benefit to you.

To summarise the example that has been illustrated in the chart, completely hedging a $102,680 share portfolio for one month cost the client a net sum of $43.57. It's cheap insurance, and it means you don't have to sacrifice any tax benefits from holding onto your investments, should you wish to temporarily exit the market before holding your positions for 12 months.

Implementing an approximate hedge

This hedge will be imperfect and is not recommended unless you have extremely broad market or sector exposure.

The quickest and most cost effective way to create a portfolio hedge is by selling an index or sector product that represents a rough equivalent of your portfolio. With a portfolio that doesn’t hold similar weightings of the top 20 ASX companies when compared with the ASX 200 index, however, your returns may not even be close to what the market returns are, therefore the hedge will prove largely ineffective.

Here is an example, using a comparison with the hedge illustrated in the first scenario.

Portfolio value on 30 April: $102,680.00
Market (ASX 200) level on 30 April: 4807.4
Portfolio value divided by the market: ($102,680/4807.4) = 21.36
Sell that number of index CFDs: Sell 21 (rounded) Aussie 200 CFDs
Portfolio value on 31 May: $93,506.40
Portfolio loss from 30 April: $9,173.6
Market (ASX 200) level on 31 May: 4429.7
Profit from hedge: $7,931.70
Interest earned on short position: $64.30
Overall hedged portfolio loss: $1,177.60

So you can see that, even though you saved a few dollars on brokerage, your hedge proved less than perfect and, as a result, you lost $1,177.60 in the process.

If you would like more information on implementing a portfolio hedge, please contact a Rivkin Securities representative on 1300 748 546.

Tarfaya and Rivkin Securities have tried to ensure the soundness of the opinions and recommendations, as well as the accuracy of the information used to derive them, but it makes no representation and takes no responsibility as to the soundness of any opinion or the accuracy or completeness of any information in The Rivkin Report and Rivkin Trading Report. You should invest only an amount that you can afford to lose. If you are borrowing money to invest or you are investing in derivatives, including Contracts for Difference (CFDs), you may lose more than your original investment.

All opinions expressed represent The Rivkin Report and Rivkin Trading Report views as at the date of publication and may change without notice. The Rivkin Report and Rivkin Trading Report is for information purposes only, and is not intended as an offer or solicitation with respect to the sale or purchase of any security or financial product.