Add Punch to Your Portfolio

Do you recall your mother’s advice about how a single piece of bad fruit doesn’t condemn everything in the produce department? That’s how former hedge fund executive Wayne P. Weddington III feels about Bernard Madoff and his alleged multibillion-dollar Ponzi scheme.

That’s just the sort of homespun wisdom readers will find in Weddington’s new book, Do-It-Yourself Hedge Funds (Hachette Book Group; $24.99).  In the tome, Weddington, a former senior trader with Caxton Associates, explains how average investors can benefit from employing hedge fund-like tactics. And while Madoff may be the spoiled golden delicious that might make you question the rest of the bushel, Weddington says you’d be making a mistake to throw away some very sound lessons hedge funds offer in times such as these.

The primary objective of hedgers is to minimize risk. In order to “reduce the consequences of being wrong,” as Weddington puts it, hedge funds employ several creative tactics. Example: They invest in several companies within the same sector, long and short, as a way of taking advantage of broad trends in the global economy. That explains why Weddington is such a fan of exchange-traded funds (ETFs), which give average investors exposure to a range of assets–baskets of stocks, indices, currencies, and commodities.

Until last year, hedge funds enjoyed a certain mystique. What was their edge, and does it still exist?
I think my book debunks some of the myths surrounding hedge funds. A lot of people think hedge funds made money off of very high risk, high leverage approaches to investing, or by trading actively. That wasn’t central to hedge funds, however. I’ve tried to show how it’s possible to set up a portfolio to make stable returns using some of the key techniques hedge funds use.

But don’t hedge funds have an edge on the average investor? How do you close the gap?
In the past, hedge funds enjoyed access to an abundance of information that the average investor has not had. That has changed. The Internet and information posted daily and hourly on Websites such as Yahoo and Google has equipped average investors with many of the same tools. The challenge is ferreting out and making sense of what’s available.

What should individual investors make of current market conditions?
Right now, investors have to readjust their expectations. There’s a lot of money out there looking for the next big investment opportunity and to my mind,

that means the stock market and other investment markets are going to be quite volatile. This is a good time to protect your portfolio against risk.  For one, this is a time when investors should be sure they have exposure to Treasuries or fixed-income investments. As far as safe havens go, it is a good strategy to have money invested internationally and in currencies that will perform well relative to the U.S. dollar and economy.

In practical terms, what sorts of investments make it possible for readers to put that methodology to use?

I’d say ETFs are probably the best way. ETFs trade like stocks on the exchange and represent a basket of stocks or assets. There are a wide variety of ETFs that home in on any number of sectors, industries, or other investments. In some cases, ETF shares represent a stake in a portfolio of stocks–much like a mutual fund. Other times, they function as a share of commodity holdings, a bond portfolio, or even a currency.
Are there any parameters that you recommend to investors looking over ETFs?
You really should avoid ETFs with a market capitalization or total stock market worth of under $250 million and ideally, I would say those valued at more than $1 billion are the best. ETFs, like mutual funds, make money by charging fees that come out of returns. So, the greater the size of the ETF, the smaller the percentage fees taken out of returns.

So where do you think risk-adverse investors should go this year?
I’m looking at ways to preserve capital in the current environment. If you’ve read investment books, you know that everyone should own bonds in a well-balanced portfolio.  The way 2008 shaped up, this is a very good time to build a position in bonds. That’s why I think ETFs that invest in Treasuries will do well–they aren’t paying a very enticing yield, but at the same time, a small yield beats a negative return. I’d consider the Barclays Capital Intermediate Term Treasury (ITE), which holds a basket of bonds from an index that was named after Lehman Brothers–which did a lot of bond market tracking.

You don’t sound bullish on stocks.  Is there something else you’re looking at?
I think a currency ETF, the Currency Shares Swiss Franc Trust (FXF) makes sense right now. Switzerland is a safe haven, international domicile–it fits the description of what I

mentioned earlier. The Swiss franc has a reputation as a shelter currency that many people hold when the world’s economy is unstable. While the franc was weak much of last year, it rallied beginning in November once the global economic crisis got worse.  In the recent past, the U.S. dollar has served the same function as the Swiss franc. This time, however, the U.S. government has been essentially printing money in order to stave off a deep recession, an action that will weaken the value of the dollar.

What’s your thinking on gold, then?
I’m not a huge fan of gold, simply because it’s only utility is that it’s shiny. But there’s no escaping the fact that the market tends to value the precious metal as a safe haven. In a year when stocks may be very volatile and when the economy is in bad shape, shelters where investors can protect their capital will have value. For that reason, I think gold prices could get above $1,000 an ounce this year and that a small investment in the ETF iShares Comex Gold (IAU) could pay off in 2009.

This article originally appeared in the April 2009 issue of Black Enterprise magazine.