Manage your exposure to volatility

Investors now have a surprising array of choices beyond the extremes of 'do nothing' or 'get out'. With the growing sophistication of investors, products listed on ASX and with strategies employed, investors can determine the extent that they wish to participate in these markets and how they wish to do it - either directly or through a range of packaged or structured solutions listed on ASX.

Investors can sit tight, protect their portfolio from any further downward pressure, look for value (and buy) stocks they are following, or adopt more active strategies to trade the direction of the market. The good news is that to implement any of the chosen approaches there is a range of products listed on ASX that can play a part. However, as always, there are risks and large movements over short timeframes can dramatically affect outcomes, particularly in volatile markets.

Do nothing

'Doing nothing' is a viable option for many investors who have been invested for some time - the history of the All Ordinaries, our broad benchmark index, shows that over time the value listed on ASX has continued to grow. View the market performance over the last 100 years (PDF 110KB)

Buy insurance

Those concerned about the value of their portfolio and who may not have the inclination to wait for the correction to pass and growth to continue can put in place a protection strategy using ASX Exchange Traded Options (ETOs). ETOs may provide peace of mind as well as an exit strategy if the market moves below the point where they would prefer to exit.

Go shopping for value in the market

Volatile markets usually prompt value investors to look for 'bargains' or what should probably be referred to more appropriately as 'stocks priced at their fair value'. Market corrections are often preceded by a market that has run up in value quickly, with some stocks considered as overpriced. It may not be until there is a significant movement downwards that value investors believe a stock is priced at its fair or intrinsic value. So what is fair value and how is it determined?

A value investor values a prospective investment on a financial basis and then relates that to the value of its shares on a value or price per share basis. The value investor may have run the ruler over the company and come to the assessment based on its fundamentals that it would be a 'good buy' at a lower cost. Value investors have the disciplined approach to wait until there is a correction that brings the market price and the value inherent in the company closer together, or the underlying value of the company per share rises to its stock price.

Investors can value companies themselves and wait for the price and their valuation to align. This can be time consuming and it may be difficult to monitor a portfolio of prospective value opportunities. An alternative may be to choose a professionally managed entity such as listed investment companies (LICs) which are always vigilantly looking for value in the market. Some LICs, which have operated in the Australian market for over 70 years, have been focusing on investing for value for many years. They can invest in a range of other ASX listed entities - usually within the top 50 to 100 stocks on ASX. These entities are easy to value themselves - because their intrinsic value is the value of the stocks they invest in - their net tangible assets (NTA) that they are required to provide to ASX each month. They can trade below their NTA if their share price on ASX is below the value per share of the investments they hold, or at a premium.

For many investors, buying an LIC on ASX and paying a management fee to an LIC manager is an effective way of ensuring they have some one looking for value in the market for them. If an LIC is trading at a discount, (i.e. its share price is below the underlying value), there may be an opportunity to buy it and gain exposure to the underlying value of the stocks it holds and the associated distribution and franking credits.

To find out more about LICs, to see performance and monthly NTA tables visit the ASX LIC website.

Pay something now and the balance later

Instalments, which are structured with two payments - one now and the second and final payment in the future - have proven a popular way for investors to effectively use less capital to gain access to the same level of income and franking as if they had invested more.

Many of the principles of value investing apply to using instalments. The starting point when using instalments is to choose the stock you wish to invest in first and then the instalment to suit. So how do investors pay less for full entitlement to dividends and franking credits?

Those familiar with the Telstra Instalment Receipts (IRs) will recall how an investor made an initial payment (first instalment) and was obligated to make a second and final payment at a future date. At such time as the final payment was made, investors received Telstra shares. However, even before the final payment was made, investors in the IRs received entitlement to full dividends and franking as though they owned the Telstra Share. They had the option of selling the Telstra IR on ASX at a known price and the obligation of making the final payment transferred to the purchaser of the IR.

Instalments are offered by investment banks over a range of ASX 'top 50' listed entities, including some LICs. There is a notable exception between the characteristic of instalments and the Telstra IR example. With the instalment the final payment does not have to be made. This is because the first instalment includes an amount to protect the instalment issuer against the final payment, which is a loan, not being made. The loan is non-recourse, meaning the investor can choose not to make that second payment and may choose to do so when the value of the share over which the instalment is offered is less than the sum of the first and second payments. However, if the investor has selected a value stock over which to buy an instalment and it has appreciated over the period between first and second instalments then they have not only received all the benefits of dividend payments, but have acquired a valuable asset.

The benefits of instalments include being able to use about half the capital to make the first payment, receiving the full dividend and franking benefits, being able to choose not to make the second payment and not being subject to margin calls on the loan component.

If you'd like to find out more, ASX is running a lecture series to help investors grow their understanding of instalments and how to apply instalment strategies. Register now or visit the ASX warrants website to find out more information including a list of instalment issuers.

To find out if an ASX listed stock has instalments available, visit the company research area on ASX website enter the ASX company code, scroll to bottom of the page and click through to see what's available.

Interested in more advanced trading strategies?

For some, market volatility offers the chance to 'trade direction' - that is, to take a view on which way the market will trend and use specific trading products to profit from short term strategies that allow the trader to position themselves ahead of the market's direction. A common strategy often referred to is to 'short the market or a stock'. In essence, this is a strategy that effectively allows the trader to benefit when the market or a particular stock falls below a pre determined point or price at a future date within a known timeframe.

There is a big step between applying this type of trading strategy and implementing investment strategies - some of which have been outlined above. However, there are a range of products available through ASX that are available to traders across a range of risk profiles to match traders' needs.

Trading warrants - structured in the same way as instalments (see paragraph above) - can provide limited downside risk, with loss limited to the extent of the first payment. However, there are some trading warrants that have particular characteristics that will see a trader 'knocked' out of the market if the underlying hits certain points and, as always where there is an element of gearing to enhance performance, there is a heightened element of risk.

Gear into a market recovery without risk of a margin call

Macquarie discusses investing in the current market environment and gearing through instalments that offer investors an easy way to gain exposure to a recovery in the market, without any short term risks of margin calls.