Five Ways Hedge Funds Brace for a Stock Market Crash, and You Can Too

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Investors almost always worry about a stock market crash, but when headwinds start to look stronger than the positive forces, they really start to worry that the rug can get yanked right out from under them. Perhaps what retail investors should do is try to learn what the professionals do with their clients’ money and their own money. Very few fund managers sell out of stocks entirely. After all, cash never rallies, and it is widely known that bull markets always seem to crawl a wall of worry.

24/7 Wall St. is identifying and discussing several strategies that investment managers, hedge funds and market gurus use to keep their toes in the stock market but manage to avoid major risk of a stock market crash. Performance and assets under management are everything to the hedge funds and institutional money managers, because their asset base and their performance are how they get paid. Now that the 2% management fee and 20% performance fee structure has been changing, these managers have to guard against too much risk leading to too high of losses.

Even after a summer pullback, the stock market performance of 2013 was better than most fund managers have seen in a decade or more. The last thing that a portfolio manager wants is to see a stock market crash rob them of their strong performance. Imagine trying to explain to clients how you wanted more upside even after stocks have more than doubled from the lows of 2009, even with all the warning signs that were evident in August of 2013.

24/7 Wall St. looked at five different strategies that many of the top hedge funds and institutional money managers may use to prevent a total wipeout of their performance. These strategies do not have any significant barriers to entry. Frankly, they can be used rather easily by any cautious investor.

These strategies include writing call options or buying put options, as well as shorting exchange traded funds (ETFs) and futures. We have of course discussed the method of gradually selling out of profitable positions rather than selling the whole boat, and there is the method of simply rotating into defensive shares. These are all discussed in detail, with examples for clarity.