A “hedge” is the financial markets jargon for a holding in your portfolio that is there for defensive purposes. It’s very much like having an umbrella: on a rainy day, you’ll still get wet but won’t get soaked – and you can dry off and get back to normal more quickly, too. Typical examples are gold, bonds or trend-following funds (these use algorithms to try to generate positive returns in most market conditions).

Most people agree it’s worth owning an umbrella and carrying it with you on days when it might rain.

The trouble is, they aren’t guaranteed to work – especially when markets experience severe turbulence over a short period of time. Think of when it’s really windy as well as rainy – your umbrella might turn inside out or one of the spokes breaks.

And even if they do work, clients won’t always *feel* great. And that’s a bit of a problem from an adviser’s point of view.

When markets are humming along nicely and everyone’s portfolio is going up, hedges act as a drag. And if this goes on long enough, eventually the client will think, “What’s the point of having this dud in my portfolio? It’s just detracting from returns.” (Or, “I’m carrying this umbrella around for no reason. And I keep leaving it on the Tube so it’s costing me even more.”)

When markets are in turmoil and (hopefully) the hedges provide some protection, well, nobody really thanks you then, either. You have the umbrella, but when it’s bucketing down, you still get wet: your portfolio might still be down – and therefore you’ll feel pretty miserable.

The fact that it’s down less than it would have been otherwise – thanks to your hedges – provides small (and cold) comfort.

In other words, for most people, how they assess investment performance – and more importantly, how they feel about it – is asymmetric. On the way up, relative performance matters (“I could have just bought an index tracker and done better!”). On the way down, absolute performance matters (“What do you mean you’ve outperformed – I’ve still lost money!”)

This presents a conundrum, of course. The commercially sound thing to do as an adviser might be not to bother with hedges and cross your fingers. That would have paid off handsomely over the past decade or so, with a handful of exceptions such as early 2020 and most of 2022. But even in those exceptions, most portfolios were still down, so as an advisor you face the “small and cold comfort” issue.

So, to hedge or not to hedge? I guess it comes down to this: how well do you understand your client? Experience and maturity (in financial terms) will eventually, for most people, help them see the value of hedges. Education can fill the gap until experience catches up – and this takes a lot of time and effort. Ask yourself how much time your advisor is spending with you thinking about and preparing for a deluge.