After the best August returns for U.S. stock benchmarks in decades, investors are angst-ridden over the possibility that the bullish party in equities could come to a screeching halt. What’s an investor to do?
Lofty valuations, a tightening 2020 presidential election race between former Vice President Joe Biden and incumbent Donald Trump, and a month that is seasonally considered the weakest for equities, all provide ample reasons for waxing investor agita, following a 57% rise for the S&P 500 SPX, +0.42% and a rise of more than 53% for the Dow Jones Industrial Average DJIA, +0.28% from coronavirus-induced lows back in late March.
Against that backdrop, analysts at UBS, led by Mark Haefele, recommended a trio of strategies that they said could help to mitigate downside risk.
But before enumerating Haefel & Co.’s suggestions, the UBS folks said that remaining on the sidelines wasn’t an option, in an environment like this one in which the Federal Reserve has declared a lasting low-interest rate environment and injected historic amounts of liquidity into the financial system.
The UBS team says it understands “that investors may be wary of committing capital to markets given the uncertainty surrounding COVID-19 and valuations becoming more expensive”…but notes that “drawbacks” to staying on the sidelines remain plentiful.
“Stocks remain supported by Fed liquidity,” the analysts argued but noted that returns in that environment can still be quite positive. “Research shows that entering the market all at once has historically offered the best outcomes—even at record highs, where subsequent 12-month returns have averaged 12% since 1960.”
Here’s UBS’s three strategies in brief:
Dollar-cost averaging
What it is: Dollar-cost averaging is buying into an asset with a fixed dollar amount at fixed time intervals. It won’t protect you against losses completely but it could minimize the impact or may reduce the risk of buying a high-price stock.
UBS recommends “establishing a set schedule—generally within 12 months or less—to reduce the cost of missing out on gains. In addition, we recommend accelerating each phase-in tranche if there is a market dip of at least 5% or 10%.”
Put options
What it is: A put option is a derivative that gives its holder the right but not the obligation to sell a set number of underlying shares at a set price, called the strike price, before a certain time. Puts can be used to express bearish opinions of an asset. They can also serve as a hedge, or insurance, against turbulence.
UBS recommends being a put seller, collecting a premium from the buyer, as one would by selling an insurance contract.
“In doing so, the put-writer receives a premium, which during times of volatility can be relatively high. If the stock price falls below the agreed-upon price, the seller in addition to the premium takes delivery of the stock, which is a particularly attractive strategy if they were willing to increase equity exposure anyway,” the strategists write.
Structured investments
What it is: Structured investments are investments that combine the feature of a fixed-income security and an option like a put, for example. They can be less liquid than bonds or stocks, however, and complex. The benefit of such bank-issued products is that they can be customized for a given investor but it can be somewhat risky depending on the issuer of the obligation.
UBS recommends structured investments as “an alternative to directly purchasing options strategies or other derivatives, some investors may be willing to fully commit their cash upfront in exchange for a structured investment that provides asymmetric exposure to the market…”
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