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Time to Tend Your Hedges?

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The following is an excerpt from MICHAEL CONNOR | July 24, 2017 | Barrons.com |

Equity market peaks (and troughs) are impossible to identify in advance. But this doesn’t mean that equity investments should simply be “set it and forget it.” At times when stock markets seem fully valued, like today, investors may look to protect some of those gains, either by de-risking their portfolios or by adding diversifying strategies to their asset allocation. And for investors who are either implicitly or explicitly following a glide-path-style approach, it may make sense to de-risk as equity prices rise.

Traditionally, when faced with what appear to be fully valued equity markets, many investors would reduce risk by shifting allocations from equities into fixed income. However, given low yields across much of the global bond market today (thanks largely to years of extraordinarily accommodative monetary policy), some investors are looking for other ways to manage their equity risk exposures.

Lessons from the VIX

The Chicago Board Options Exchange Volatility Index (VIX) is a measure of the cost of options on the S&P 500 Index, and it is often referred to as the “Fear Index” because it quantifies how much investors will pay to hedge against a sharp fall in equity prices. Historically, the VIX has been high during times of crisis, and low when markets are calm. Today, the VIX is near a 20-year low (see chart), which means that long option costs on the S&P 500 Index are also near 20-year lows.

However, there are a number of risks and uncertainties in the global economy that could affect market prices (for more on the potential policy pivots that could influence global markets in the coming years, please read PIMCO’s latest Secular Outlook, “Pivot Points”):

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