An Equity Strategy Built for Election Uncertainty
As the momentous elections on November 5 approach, the financial media will be replete with advice on how investors should position themselves for any outcome. There are, of course, significant policy differences between the two Presidential candidates on taxes, housing, energy, health care (including Medicare), tariffs, international trade, regulation and much else. It’s a tight race with an unclear outcome, but market pundits are going into overdrive to predict the market and investing implications of a Trump or a Harris victory.
In fact, even if we were clairvoyant enough to predict the presidential vote at the polls, there would still be a host of unknowns. For example, control of Congress—whether it remains divided or under one party’s thumb—could determine the success of either presidential candidate at pushing through his or her policy agenda.
Markets are nonpartisan; making rash investment decisions based on emotions or your political outlook is generally unwise. “I wouldn’t presume that either candidate’s campaign rhetoric on the economy will necessarily lead to policy changes, especially in a sharply divided Congress,” says Naveen Malwal, an institutional portfolio manager at Fidelity Strategic Advisors. “In fact, the economy and stock market have grown on average under every different combination of presidential and congressional party.” In other words, investment decisions should turn on long-term fundamentals and not predictions of near-term political outcomes.
Of course, the markets may well turn volatile in the run-up to the election and afterwards due to election, political and policy uncertainty. Some investors will seek to hedge perceived risks by buying puts on the market. More bearish investors may engage in shorting the markets, perhaps with double or triple leveraged ETFs. Still others will try to reduce downside equity risk by buying some of the new breed of actively managed stock option ETFs cooked up by Wall Street, such as buffered or covered-call ETFs. Still others may simply panic and slash their portfolio’s equity exposure, perhaps wrongly believing that they can time the markets and get back in on time.
A Different Approach to Risk
There is an entirely different strategy that investors can consider: investing in a long-short fund. A long-short fund, which can be used as a core absolute return strategy, allows anxious investors essentially to play it both ways (aka having their cake and eating it, too). The short side provides downside risk management if the market does plunge after the election; the long side provides upside potential in a bull market, and works to compound wealth in equities over the long term. Combining short positions with long positions in an equity strategy dampens portfolio volatility (typically by one-third to one-half) and cuts beta, or market exposure, which may be just what the doctor ordered for jittery investors during election season. If investors subsequently perceive sunnier skies, then they can add some beta exposure to their portfolios.
There are multiple ways to implement a long-short strategy, of course, but currently one could make a strong case for a fundamental stock-picking approach, particularly on the value side of the spectrum. After an extended period of outperformance by a handful of mega-cap growth companies, the pendulum may have swung back to fundamentals and value judging by results in the just-completed July-September quarter. The Russell 1000 Value Index returned 9.4% during the quarter, about triple the return for the Russell 1000 Growth Index, and relatively depressed small caps outshone large caps.
There are numerous examples of a broadening rally in the third quarter. The equal-weighted S&P index beat the market-weighted index for a change. The best performing sectors were utilities and real estate (up 19% and 17%, respectively), both interest-rate sensitive value sectors. Industrials and financials, two other value sectors, also performed well.
For a bottom-up, value-oriented long-short stock picker like LS Opportunity Fund, this could be fertile grounds. For instance, declining interest rates will create winners and losers in a rate-sensitive sector like financials. This implies that in the same portfolio a portfolio manager can express positive views about financial companies that benefit from higher rates and negative views about financial service companies that are negatively impacted by the interest-rate factor. A well-managed long-short fund may be just the ticket for anxious equity investors to remain in their seats and reap the long-term benefits of stock appreciation.