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How can I hedge my mutual fund portfolio?

Dhirendra Kumar explains how to navigate through various market conditions

How can I hedge my mutual fund portfolio?

How do I hedge my portfolio of mutual funds? As the market rises, investors don't generally sell off their investments and stay invested. However, the corresponding fall in the market may worry the investors. What should one do to guard their long-term investments?
- Mohan Kumar

You cannot hedge your portfolio very easily. When an equity mutual fund falls, everything falls, such as the various indices - Sensex, NIFTY, Small cap index, etc. Hence for hedging your mutual fund portfolio, look for investing in another asset class. There is no provision of hedging in mutual funds.

My advice would be to form an asset allocation rule for yourself, which is easy to implement. For example, you decide that 50 per cent of your portfolio will be invested in equity while the rest 50 per cent will be in debt. As the equity markets rally, 50 per cent equity allocation may rise to 70 per cent of the portfolio. Remove the extra 20 per cent and invest it back into debt. This will help you to create a partial hedge for your portfolio.

The one thing that I have understood looking at the markets for the past 25 years is that you cannot predict the market in the short term, so hedging it over the short term is impossible. You may know that many people had removed their money from the market in the past year, anticipating a fall in the market. That's when they wanted to enter the market again. However, to their surprise, they did not get such a chance. Hence, your prediction of the market may prove to be right or wrong at times. However, you may miss out on the market rally.

Thus, I would suggest you decide on an asset allocation for yourself and keep rebalancing your portfolio. Do make a rule for rebalancing your portfolio as well. For instance, as the asset allocation of any asset class moves 10-15 per cent away from the desired allocation (in either direction), you would rebalance your portfolio. It would help you make use of both the rise and fall of the market. If you would have your money invested in debt, only then would you be able to move that to equity as the market falls. If your entire investment were invested in equity, you would be left with no money to invest as the market falls. This is an excellent automated way to hedge your portfolio. It will help many investors earn a little more on their investments while having less regret if the market falls. The market tends to rise slowly and fall rapidly. An asset allocation and rebalancing rule is required to cushion your investments from the downfall and provide psychological comfort.

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