This depends on whether you prefer to tactically change your risk for a brief period (in light of immediate concerns) or strategically modify your family’s risk more permanently. If the move is short-term, consider a derivatives-based strategy. An overlay strategy utilizing a futures contract(s) can quickly, easily and inexpensively (from both tax and trading-cost perspectives) alter risk. Although more expensive and complicated, put options can likewise hedge losses in specific family legacy positions. Yet derivatives bring new risks. Futures contracts are far from perfect at hedging concentrated portfolios. Counterparty risk needs to be considered. Moreover, derivatives can increase ordinary income tax exposure.

Because it is nearly impossible to predict short-term market changes, you might instead consider permanently restructuring the portfolio. Broadly diversified global portfolios that include alternative equity asset classes are often less expensive and more effective at reducing downside risk than hedging with exotic strategies.
Brent Brodeski, Savant Capital Management, Rockford, Ill.

If you must hedge, purchase a put on a broad market index. The cost of purchasing puts on specific stocks to protect against a 10 percent decline is likely to be high. Assuming that most of the risk in the equity portfolio is systemic risk, the costs of maintaining those hedges may outweigh the potential benefits.

The bigger question is: How do you want to manage risk? Equity market declines of 10 percent or more are common occurrences, and can occur without warning. Hedging is just a short-term solution—which can become very costly to maintain. It would be better to manage risk by deploying the rest of your assets in a manner that eliminates your concerns about your equity exposure. Then you will not need to hedge, and your family office staff will not be called upon to attempt to predict the short-term behavior of the stock market.
Roy C. Ballentine, Ballentine, Finn & Co., Wolfeboro, N.H.

The most cost-efficient hedge is to short the index most closely correlated to your holdings. You could also short stocks closely correlated to the founders’ shares. There are more effective strategies, but they carry higher costs either in cash, opportunity or both. Before hedging, assess your desire for safety vs. opportunity. While a perfect hedge limits downside risk, it also caps upside potential.

Perhaps an imperfect hedge—one that allows upside potential while minimizing downside risk—will best meet your goals. There are scores of strategies available using options, futures and derivatives. Although less cost efficient, they may be more effective and provide more capital appreciation if your market assumptions prove incorrect. But before implementing any hedge, circle back to your long-term investment objectives to make sure your concerns cannot be mitigated by changing the allocation of your public equities.
John Bird, Albion Financial Group, Salt Lake City.

Focus on solutions that minimize costs while maintaining as much flexibility as possible to deal with future market conditions.

For option hedging, there are two basic ways to go: custom options or market index options. Market makers can tailor a solution specific to your situation; it will be expensive and limit your future flexibility. Index options are less costly, but may not provide a sufficient hedge.

Additional issues should be considered. With capital gains taxes at only 15 percent, should you just sell some stocks? Would buying an interest in oil and gas production satisfy the hedging needs? A more basic question to ask: Although a downturn of greater than 10 percent is disturbing, unless you must liquidate in the downturn, the loss is only temporary—so how much hedging is appropriate?
David Diesslin, Diesslin & Associates, Fort Worth, Texas.


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