Sun, sea and … S&P 500 put options

To help my wife and I stave off the post-Christmas blues, I recently locked in a family holiday. A nice flaming ball of hydrogen in our future to get us through those dark winter nights. Although, this year’s holiday may be more work than last year’s…

While booking the flights and hotel and car, it was also time to renew the travel insurance too. Insurance can be one of the most frustrating bills to float out of your account – and you have to watch it too, because before you know it they’ve tried to fling a 20% premium increase past you. Every time I see these payments go out, I daydream about more exciting things I could have done with the money.

However, insurance is the one thing we all buy in the hope that it’ll be a complete waste of money. What we’re buying isn’t some sort of instant gratification, like a pint of best, or indeed the chance of a potential return (unless you’re very deep into insurance fraud). What we are buying is actually peace of mind and the ability to rest easy knowing that if the worst should happen, we are covered.

Of course, buying insurance takes a bit of forethought: you have to buy it before you actually need it. It’s no good slipping over by the pool on your family break and then calling up your insurance broker. Insurance in investments works in exactly the same way: trying to buy insurance for your portfolio when you really need it will sting your wallet more than a round of cocktails at a swim-up bar. But when the metaphorical seas are calm and the sun is shining, you can find portfolio protection at a pretty decent price.

In our multi-asset portfolio funds we are always looking out for portfolio insurance we can buy at a reasonable price. The cost of holding these protective assets sometimes means that, when markets rocket off in a straight line, we can be held back a little. But, as with your holiday, car, or life insurance, you’re buying peace of mind and comfort. Yes, if you hadn’t bought the insurance then you could have used that money to raid the hotel mini-bar, but you’d also be at risk of an eye-watering surprise from the doctor when you hurt yourself doing running bombs drunk.

Put simply, our portfolio protection gives us peace of mind that if markets go through a sharp fall or correction, the portfolios shouldn’t suffer more than their risk targets suggest. We have used S&P 500 put contracts in the portfolios over the last few years and they have come in handy. These options are probably the closest thing you can get to an investment insurance contract. Your losses are capped at the premium you pay for the contract and the excess you agree to (the strike price of the contract; under that value, you’re covered). 

These contracts were instrumental for our funds being able to weather the heavy drawdowns in the fourth quarter of 2018, as well as a number of smaller dips since. We continued to add more of these options throughout last year and, most recently, in December last year. While we are still broadly positive about stock markets in the year ahead, we have already explained how we like to buy insurance well before we might need it.

So, while Will recently wrote about more dispensable subscriptions, insurance is definitely not one of them! Don’t worry about that direct debit for your holiday insurance, it’s there so you can enjoy your sun and sangria. Just make sure you’ve bought it at the right time and not when you’re on the ambulance gurney – or when you’re looking at a sea of red on the screens.