Successful stock portfolio management relies on an in-depth risk management strategy, and this CPE-eligible course covers its major techniques – hedging, asset allocation and rebalancing among them.
Diversification – Spreading investment funds across various stocks, market sectors, asset classes or industries helps reduce portfolio volatility and risk while helping moderate price swings during downturns.
Derivatives
Derivatives are financial instruments that allow participants to gain exposure to specific assets without actually purchasing or selling the asset itself. Derivatives are used by both investors and large firms as an efficient way of protecting themselves against specific risks or diversifying portfolios – though their increased risks can increase returns while simultaneously diversifying portfolios.
I use regression analysis to explore whether the type of derivative instruments that new derivative users choose are appropriate for hedging. Through this approach, I find that choice of derivative instruments relates closely with firm risk before and after starting their program; I conclude that such correlation is indicative of effective hedging practices.
The results also demonstrate that New Derivative Users’ choices may be determined by their stock market capitalizations, meaning scale economies could lead to substantial cost reduction in their derivative programs and save them significant operating expenses.
Hedging
Hedging is a strategy used by investors to safeguard against price fluctuations in a stock portfolio and minimize losses caused by price movements. Hedging typically takes the form of purchasing offsetting positions in assets or securities related to those involved with market movements – or alternatively through derivative contracts like options and futures.
Investors looking to protect themselves against stock-specific risk often purchase put options from companies they own, while trading index options or securities that track broad market indexes is another effective means.
Hedging can provide long-term investors with many advantages, including stabilizing returns over time and mitigating concentration risk by spreading investments across sectors and companies. But it can come at the cost of higher fees and reduced potential profits, so it’s crucial for them to understand all aspects of hedging before adopting any strategies involving this practice. Using sophisticated financial instruments may make implementation a challenge as well.
Asset Allocation
A portfolio’s allocation to different asset classes, like stocks, bonds and cash equivalents can drastically alter investment returns and risk. Stocks offer the greatest potential gains while simultaneously being highly volatile; over the long haul however they have historically outshone all other asset classes.
Your ideal asset allocation will depend on many factors, including your financial goals, amount available to invest and level of risk you are willing to accept. As your needs and investment horizons change over time, so too may your ideal mix.
Asset allocation can help mitigate risk by diversifying a portfolio across asset classes with low correlations between them, but even an appropriately diversified portfolio may still experience concentration risk due to specific security selection within each asset class.
Rebalancing
Rebalancing portfolios helps ensure they align with investors’ investment goals, risk tolerance and financial needs. Rebalancing also allows for a more disciplined, unemotional approach to investing that reduces exposure to market fluctuations.
Rebalancing generally entails selling assets that have outshone others to purchase investments with underperformed returns, sometimes at a temporary loss in return but typically offset by reduced long-term risk and increased returns over the longer run.
New Users who utilize derivatives have shown significant decreases in mean and median changes to interest-rate and total risk during the first year after beginning to use derivatives, regardless of inclusion of proxies for incentives to hedge in regression analysis. These results were found regardless of any incentive schemes to hedge.
