COLUMN-The doomsday portfolio: How to invest for default

Reuters

(Corrects spelling of Tom Atteberry's name in 20th paragraph.)

By Lauren Young

NEW YORK, Oct 11 (Reuters) - What should investors do ifthey think their portfolio is facing doomsday?

It's a question more folks have been asking me as the UnitedStates grapples with the prospects of debt default. On Oct. 17the U.S. Treasury will need authority to sell more debtsecurities - or face defaulting on its obligations. Another keydate: Nov. 1. That's when more than $55 billion in federalpayments come due - and the Treasury might not have enough tocover those bills.

Even as lawmakers consider short-term funding measures,every day that the government is partially shuttered andCongress and the president remain at an impasse isangst-inducing. Roughly one-quarter of individual investors haveeither increased their cash positions or postponed buyingstocks, according to a recent poll by the American Associationof Individual Investors.

In the past week, I've canvassed more than 20 moneymanagers, strategists and financial advisers about theprobability of a default. Collectively, they manage hundreds ofbillions of dollars. None of them predict an Armageddon forinvestors. And yet ... their anxiety level is amping up, evenwith the market's rally on Thursday.

"As an investment professional, do I think we go through adefault? No," says Stephen Sachs, head of capital markets atProShares, which offers exchange-traded funds that allowinvestors to double down on the markets. "But I don't assign azero probability to it."

Adds Bruce Baughman, a veteran value investor at FranklinTempleton: "I'm no Chicken Little, but even I am starting to getnervous."

Few experts foresaw the breadth and depth of the 2008financial crisis. Since then, though, we've all learned toexpect the unexpected. It's entirely possible that a U.S.default could trigger an unprecedented global financialmeltdown.

If that isn't scary enough, here is even more bad news:Investors have few places to hide. That's because duringcataclysmic markets, even hideouts like "cash," includingreally-short-term bonds and gold, suffer as well.

Yet there are a few ways to rejigger your holdings and hedgeyour bets. Some of these moves are exceptionally risky, soproceed with caution.

BET AGAINST THE BOND MARKET

If the U.S. defaults on its debt, the biggest portfolioblow-ups should happen within the market. Yields on bonds -particularly U.S. Treasuries - could rise sharply, and pricescould fall just as fast.

That's where inverse exchange-traded funds come into play.These high-octane funds short the market - moving in theopposite direction of major benchmarks, like the BarclaysCapital 20+ Year U.S. Treasury Bond Index. Some inverse ETFshave extra juice - seeking to deliver double the inverseperformance of the corresponding benchmark.

"If the U.S. defaults, the gains on these shorts would beastronomical," says Cliff Caplan, a wealth manager at NeponsetValley Financial Partners in Norwood, Massachusetts. Herecommends buying the ProShares UltraShort 20+ Year Treasury ETF if you expect the United States to default on its debt.The ETF, which has an expense ratio of 0.93 percent of assets,is up 21.09 percent so far this year through Oct. 9. That'scompared to a 1.94 percent drop for the Barclays U.S. AggregateBond Total Return Index, which is a proxy for the U.S. bondmarket, according to Lipper, a unit of Thomson Reuters.

Another popular option to bet against bonds is ProSharesUltraShort 7-10 Treasury ETF. Year to date, it is up6.85 percent. The fund charges 0.95 percent for annual expenses.

"Caveat emptor," warns Tom Roseen, head of research servicesat Lipper, who says these volatile funds are not ideal forbuy-and-hold investors.

Indeed, Caplan bought an inverse bond ETF in 2011 ahead ofthe ratings downgrade on U.S. debt by Standard & Poor's. "Ididn't put a lot of money in it, but percentage-wise it was adisaster because interest rates went down, not up," he says.

FOCUS ON SHORT-TERM DEBT

Short-term debt isn't as sensitive to interest-rate moves aslonger-term debt.

That's why Jessica Ness, director of financial planning atGlassman Wealth Services in McLean, Virginia, recommendsultra-short-term bond funds, including FPA New Income.It is up 0.38 percent for the year, according to Lipper.

The fund gets high marks from Lipper for capitalpreservation. (FPA's motto: "We don't like to lose money!")

The disclaimer here is that some institutional investors aredumping short-term debt because of worries that it will bedefaulted on first.

Even so, "our concerns about the bond market remain aboutthe same," says co-manager Tom Atteberry. Atteberry's team isfocusing on bonds secured by assets that, he says, "are criticalto a business or individual, can be easily valued and can beforeclosed on in an efficient fashion in the event of defaultand the owner has equity invested along side us."

Some other bond funds Ness recommends: Franklin AdjustableU.S. Government Securities, which has an expense ratioof 0.62 percent, and Driehaus Select Credit. Bothfunds are essentially flat for the year.

BUY GOLD

Gold is considered to be the place to hide in the event of amarket meltdown. Lately, it hasn't looked especially safe - theprice per ounce of the precious metal has fallen about 22percent this year. And during the last financial crisis it lostluster, too.

"For doomsday clients, I typically recommend that they buysome gold - not in their portfolio as an investment, but ratheras an insurance policy," says Carl Amos Johnson, a financialadviser at Ames Planning Associates in Peterborough, NewHampshire.

The easiest way to invest in gold is to buy the SPDR GoldShares ETF. It is backed by a stash of gold bullion heldin a vault in London.

Johnson's advice, however, is to buy physical gold coins andkeep them handy. Stash them in the treasure chest in your bunker- along with the batteries and canned goods. (Reporting By Lauren Young. Editing by Linda Stern and DouglasRoyalty)

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