Three portfolio strategies to hedge political risk

Reuters

By John Wasik

CHICAGO, Oct 21 (Reuters) - For angst-addled marketwatchers, the U.S. debt ceiling and budget chaos has been likeone of those amusement-park rides in which you ride upside down.It's harrowing and probably not over yet.

In addition to market and credit risk in the stock and bondmarkets, you need to be acutely aware of political risk. Thatmeans finding pockets of profit that are not dependent uponWashington.

Here are three strategies:

1. Balance risk in one fund

If you're a fairly moderate to conservative investor, havinga balanced fund as a core holding could replace several fundsthat hold just stocks or bonds. While you're not entirelyinsulated from political risk, it's more of a hedge than beingcompletely exposed to stocks or bonds. But can you get onemutual fund to do this for you in a tactical way?

The Oakmark Equity and Income Fund is an activelymanaged fund that shifts between stocks, bonds and cash. But theOakmark fund is not your typical 60-percent stocks, 40-percentbond mix. The fund can invest up to 35 percent of its assets innon-U.S. securities, which it has done with stakes in NestleS.A. ADR and Diageo PLC ADR.

Unlike most balanced funds, it has nearly three-quarters ofits assets in stocks, with about a quarter in bonds and cash.It's done well to date; it's up 18 percent for the year throughOct. 18, compared with 12 percent for a Morningstarmoderate-risk index. The fund charges 0.78 percent annually forexpenses.

If you want a more traditional, fixed approach and passivestyle, then consider the Vanguard Balanced Index Fund,which is up about 14 percent for the year through Oct. 18 andcharges 0.24 percent annually.

2. Buy emerging-markets bonds

If owning U.S. Treasuries makes you skittish after thedebt-ceiling stand-off, then diversifying into emerging-marketsbonds might provide a good idea.

Emerging markets bonds, which tend to be much more volatilethan the balanced approach, should be considered "satellite"holdings for the income portion of your portfolio.Dividend-payers, in contrast, can be held long-term and be partof a growth-and-income strategy.

Although bonds from developing countries have been taking iton the chin this year, they are poised for a rebound if theFederal Reserve continues its easing policy. A worthy choice isthe iShares JP Morgan US Dollar Emerging Markets Bond ETF, which charges 0.60 percent for annual management.

The fund, which holds bonds from Brazil, the RussianFederation, Turkey and other developing countries, is down 5percent for the year, but up 13 percent over the past five. Ityields nearly 5 percent.

Keep in mind that emerging-markets bonds, which tend to bemuch more volatile than the balanced approach described above,should be considered "satellite" holdings for the income portionof your portfolio.

3. Hold U.S. dividend-paying stocks

For most investors, a steady dividend is cash in hand thathas little or no connection to Washington's bipolar financingtalks. In addition, dividend-payers can be held long-term and bepart of a growth and income strategy.

According to S&P Dow Jones Indices, a few companies arepoised to raise dividends because of strong profits and cashflows. This elite group includes AFLAC, Inc., AT&T, Inc., Emerson Electric and McCormick & Co..

If you don't have a portfolio that holds stocks like thesethrough dividend-reinvestment plans, a good vehicle for holdinga variety of them is through the SPDR S&P Dividend ETF,which charges 0.35 percent annually.

The fund gained about 23 percent for the year though Oct. 18as dividend payers continue to remain in favor among defensiveinvestors. That return compares with 22 percent for the S&P 500index over the same period, and the fund yields 2.5 percent.

Of course, not even experienced Washington pundits canpredict what shape political risk will take in the future asboth parties tussle over the budget and federal debt ceiling.

Only one thing is certain: government disruptions and budgetslashing will deprive the U.S. economy of even more growth,which could push the nation closer to another recession. If thathappens, you can hedge political risk all you want, but it won'talleviate the damage to the stock, housing and labor markets.

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