You won’t believe how some advisers are hedging market risk

As stock market volatility starts creeping higher, some financial advisers are reading the signals and adjusting client portfolios to try to hedge the risk of a market pullback like the one investors experienced at the end of last year.

“We’re not trying to be market timers, but we’re very cognizant of where we are in the market cycle,” said David Demming, president of Demming Financial Services.

“If we go another month and a half, this will be the longest recovery in market history,” he added. “We’re nearing the end of the cycle with high valuations, and that’s causing us to rebalance by reducing our domestic equity positions while increasing our overseas positions.”

Mr. Demming’s defensive strategy also includes investing in mutual funds that have larger cash positions. On the fixed-income side, he favors longer bond maturities.

Even though the S&P 500 Index is up nearly 16% from the start of the year, financial advisers and investors haven’t forgotten the 20% drop the market experienced from late September to the end of the year.

Add to that crude oil prices hovering near five-month highs, and the recession indicator of the inverted yield curve, where yields on shorter-term bonds move above those on longer-term bonds, and the spiking volatility starts to look like a red flag to some advisers.

“There are some late-cycle events happening and I think it’s a good time to be reducing risk,” said Christopher Beste, a financial adviser with RFG Advisory.

“We can’t time the market, but we’ve had a good run-up, so I’m reducing exposure to some large-growth areas and trying to get more bias to the value side,” he said. “I think of it as preparing the house for a storm instead of trying to fix the holes in the roof during a storm.”

Part of Mr. Beste’s risk-reduction strategy involves trimming pure equity market exposure to make room for alternative strategies, including long-short equity mutual funds. Depending on the risk characteristics of the client, he said portfolios have between 10% and 20% allocated to alternatives.

For some advisers, the new popular hedging vehicle is good old-fashioned certificates of deposit.

Dennis Nolte, vice president at Seacoast Investment Services, decided to manage risk by loading up on CDs in some client portfolios.

“For clients nearing retirement, we took half their assets and put them into CDs,” he said. “That’s mostly people who are pulling the plug on retirement in the next six months.”

Last week, Mr. Nolte reallocated the portfolio of one married couple in their late 50s who had already accumulated $1 million, shifting it from 75% stocks and 25% bonds to a balanced 50% in each asset class.

“They only need about 3% for it to work in retirement, so for them the race is over,” he said. “If you’ve made it, there’s no reason for you to undergo another 20% decline and the stress from that.”

Thomas Rindahl, an adviser at TruWest Wealth Management, is also leaning hard on the relative certainty of cash and cash equivalents to hedge what he views as looming market risk.

For nearly a year, Mr. Rindahl has been allocating 20% to 25% of client portfolios to cash, CDs and structured products that offer downside protection.

“It hasn’t always made me look great in clients’ eyes, but in the fourth quarter of last year they thanked me when they saw the downside protection aspect,” he said.

To keep a growth factor in the portfolio, Mr. Rindahl mostly trims from the fixed-income side to load up on cash and CDs.

“I think there’s risk on the stock and bond side, but in order to have a diversified portfolio that will keep up with inflation, I like a safety net of CDs, and bonds aren’t the safety net they used to be,” he said.