Should I hedge stock investment because it's "overheated"?

beeza650

I've been sitting on cash that's not keeping up with inflation for decades under some misguided view I would need it to buy a bigger house + apathy and ignorance. Enough's enough - I need to accept a house upgrade isn't going to happen for 5 or even 10 years.

I've got about 250k to invest but I feel stocks are quite overheated so I'm thinking

Product	%
HSBC FTSE All World Index Fund C Acc	60%
iShares Edge MSCI World Value Factor UCITS ETF, IWFV	25%
Vanguard Global Small Cap Index Fund GBP Acc	15%

HSBC FTSE All World Index is the core because it gives cheap, broad global exposure but it is heavily driven by the largest US growth and AI-related companies and therefore perhaps somewhat overheated.

To hedge that iShares MSCI World Value Factor tilts some money towards cheaper, less fashionable shares, reducing dependence on expensive growth (grown?) stocks.

Then Vanguard Global Small Cap Index because smaller companies are underrepresented in the main global tracker and could benefit if market returns broaden out.

What do you think please?

Worried_fool

Fine, but if you really believe that stocks are overheated it might make sense to increase your allocation to value shares, and consider some Bonds as well.

Is it not possible that shares in small companies could also be over-valued?

masonic

It's a reasonable portfolio to fit your narrative. Bear in mind that you probably won't get any downside protection from this, but it may capture greater growth potential if you are right.

Do you have the risk tolerance for 100% equities? You could see this worth £150k in a few years if you are unlucky. Most people would be unable to tolerate that sort of volatility.

beeza650

@Worried_fool yup I guess if I'm going to take a strategy I should make it count

@masonic thanks for the post...hmm why no protection? Re downside I will keep some cash spare to ride it out a dip..

megatower

It's a very personal choice, whether to do it and when to do it. I personally divest significant part to cash not that long ago.

I have the same IWFV, and better to keep an eye on it as the 'Value' part could be somewhat misleading. At the time of writing, MU occupies 14.79% of the holding! CSCO and QC also have significant weights. All of these are AI related very hot stocks. Not sure how often and the criterion for re-balancing though, as it used to have INTC not long ago but not anymore.

megatower

Have a second look, is it correct you haven't actually invested yet? I'd probably wait a bit, or DCA (dollar cost average) over time.

masonic

https://forums.moneysavingexpert.com/discussion/comment/82049958#Comment_82049958

During a crash, stocks tend to fall indiscriminately, and financials (which tend to be overweight in value funds) quite often see earnings slashed, while smaller companies tend to fall further than large cap due to the heightened risk of them going bust. So where reducing exposure to overheated parts of the market can make sense over the long term (forward 10 year returns may be higher), over the short term there often isn't anywhere to hide within equities, so you should expect to have just as difficult a ride.

Worried_fool

https://forums.moneysavingexpert.com/discussion/comment/82050019#Comment_82050019

There is an argument that some sectors, such as healthcare, are out of fashion and so have less far to fall in the event of a generalised downturn.

What do you think about (different kinds of) bonds rather than cash for providing downside protection?

Bostonerimus1

OP, How old are you and what do the rest of your finances look like? Do you have ISAs, DC pensions, DB pensions, GIAs and what about your mortgage and other debt?

masonic

https://forums.moneysavingexpert.com/discussion/comment/82050161#Comment_82050161

Bonds generally provide good downside protection. The exception is during high inflation periods where longer duration bonds will fall hard due to interest rate sensitivity.

There is also a risk spectrum, going from government, through investment grade corporate, to high yield/junk, but even the latter tend to be less risky than equities.

Value will typically not overweight healthcare due to its high R&D costs and ageing demographic tailwind (jam tomorrow), leading to premium P/E multiples despite their general lower volatility. But it would overweight defensive consumer staples and utilities, just not to the extent of financials, energy and industrials, which are all more cyclical. Having said that, the OP's factor fund overweights tech compared to the broader MSCI World index from which it picks (34% vs 28%), has very slightly more financials (14.4% vs 14%), very slightly more healthcare (8.4% vs 7.9%), less consumer staples (4.3% vs 4.9%), and is neutral on utilities (2.6% vs 2.7%).

If you wanted a defensive factor fund, then the obvious choice would be a "minimum volatility" ETF, which would be packed with utilities, healthcare, and consumer staples, but even then you should expect around three quarters of the downside of the broader market (and it won't help much if all economic activity is disrupted, like during a global pandemic or energy crisis). The iShares Edge MSCI World Minimum Volatility ETF looks like a better sectoral split, with less tech (22% vs 28%), slightly less financials (12.8% vs 14%), much more healthcare (13.6% vs 7.9%), consumer staples (10.2% vs 4.9%), and utilities (8.1% vs 2.7%).

But people generally buy value and defensive funds for different reasons: the former in the hope of long term outperformance without consideration for stability, and the latter for safety and generally more pedestrian long term returns.

OldScientist

Over the last 10 years, cash (Royal London STMMF) has grown by about 21%, house prices by about 36% (2016 to 2025), equities by 260% (HSBC FTSE World) and CPIH by 42%. In other words, you are right, your cash holdings have lost about 15% of their real value over the last decade (although rate hopping using MSE would have provided better returns than the MMF).

However, the results for the next 10 years are unknown and unknowable. Holding a house fund over 5-10 years entirely in equities is (based on history) likely to grow at a faster rate than inflation, but not always and the ride is likely to be quite bumpy. The only way to guarantee real growth would be to drop the lot in an index linked gilt maturing in 5 to 10 years (real yields are currently around 1.0 to 1.7%) and hold until maturity. This might form a useful hedge.