To Protect and To Serve

The success of absolute return funds is evidence of investor appetite for downside protection, but how can you protect against market downturn in a portfolio built with ETFs?

Ben Johnson 8 July, 2010 | 10:33AM
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Recent market volatility underscores the tremendous degree of uncertainty shrouding the economic outlook. The strength of the 2009 rebound in equity, fixed income and commodities markets suggest a V-shaped recovery. But bloated sovereign balance sheets, stubbornly high unemployment and signs that China is reining in liquidity have left market participants pausing to ponder the shape of things to come.

Many are left wondering if the financial markets may be a few steps ahead of the underlying fundamentals. With this uncertainty, many investors are seeking ways to build downside protection into their portfolios.

Defensive strategies can take a number of forms, ranging from liquidating your investment portfolio and shoving the proceeds under a mattress (a practice that seemed prevalent in the autumn of 2008 and early 2009) to piling into gold, which has been another popular trade of late. But there are other, less drastic, ways to navigate uncertainty and mitigate downside risk in your portfolio. For investors with a long time horizon, we suggest building downside protection is as simple as creating a well-diversified portfolio accompanied by a dose of regular rebalancing.

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Ben Johnson

Ben Johnson  is director of passive funds research at Morningstar.