I am a long-term investor with a very diversified portfolio. Over my 22 years of investing, I’ve learned a lot of lessons the hard way. The biggest lessons usually come in the face of a market crash, and I’ve been through four of them: The 1998 Long-Term Capital Management collapse, the 2000 dot-com bubble, the Sept. 11 aftermath and the 2008-2009 financial crisis.
With each succeeding market crash, I had more wisdom about how to respond. I’ve since developed a comprehensive strategy for handling large market corrections or a market crash.
Diversification is the single best line of defense you have against a market crash, and one of the arenas that nobody talks about are “alternatives”. These are funds that involve specific market strategies that used to be reserved for hedge funds.
These funds don’t always correlate to the overall market, and can provide a long-term hedge.
Alternative Funds to Buy: IQ Merger Arbitrage ETF (MNA)
The IndexIQ IQ ARB Merger Arbitrage ETF (NYSEARCA:MNA) is a fund that takes advantage of merger arbitrage opportunities. What the heck is that? The goal is to capture the spread between a target company’s stock price after an acquisition offer, and the price that the acquirer will pony up for the target company.
How does it do this? First, it goes long the target company as soon as the acquisition is announced. You may think that if Company A offers $100 per share for Company B that the price of Company B will shoot right to $100. That’s not always the case. The market often discounts the possibility that the merger will fail.
That’s exactly the case now with AT&T Inc. (NYSE:T) and Time Warner Inc (NYSE:TWX). The offer price was $107.50 and TWX is trading at about $99.
In the case of all or partial stock deals, the fund also shorts the stocks of the acquiring company in order to lock in the spread. All cash deals have nothing to do with the health of the overall market. Part-stock deals have some exposure. Thus, the strategy is at least partially removed from a market meltdown.
Alternative Funds to Buy: Fidelity Event Driven Opportunities (FARNX)
Another strategy designed not to correlate with the overall market are “event driven” funds, such as Fidelity Event Driven Opportunities Fund (MUTF:FARNX).
These funds target the stocks or other securities that management believes are in some form of special situation. For example, a company going through a reorganization or a proxy fight might be of interest. If a company stock isn’t worth what, say, Carl Icahn thinks and he launches a proxy fight, then an event-driven fund may take a position based on Icahn winning (or losing).
There may be a change in “beneficial ownership”, meaning a hedge fund has taken a large position, signaling an intent to push management to make changes. Addition or deletion from a market index may be a factor. There may be a change in capital structure that becomes of interest. In some cases, the market may think the company is in more trouble than it is, and heavily discount the bonds, making them attractive to a fund like this.
Fidelity launched FARNX in early 2013 and it has returned 40% over the last four years.
Alternative Funds to Buy: Blackstone/GSO Long-Short Credit Income (BGX)
Blackstone/GSO Long-Short Credit Income (NYSE:BGX) has three valuable elements to it. First, in regards to being a hedge against a market crash, the fund has at least 70% of its assets in first and second-lien secured loans.
That means the fund has made loans to a variety of businesses and have taken a security position in them. A first lien means the fund is first in line to foreclose on the borrower’s assets if they default on payments. A second lien usually means they are second in line, but often are able to negotiate terms with the first lienholder to improve that situation.
These loans historically do not correlate to market moves. In addition, the fund can take short positions, although that isn’t as frequent a strategy. The fund also generates income from its loans, and can experience capital appreciation of its assets.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. As of this writing, he did not hold a position in any of the aforementioned securities. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. He also is the Manager of the forthcoming Liberty Portfolio. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
