Despite remaining positive on equities, BMO Global Asset Management co-head of multi-manager solutions Rob Burdett is backing a market correction in the coming months. 
As such, the manager has taken out his first put option in many years in order to capitalise on this, with the US the most likely place to feel the effects first.
From a valuation standpoint, global equites look expensive, particularly in the US and UK where markets are at near all-time highs following a strong 12 months.
“Our overall view is that we’re neutral to overweight equities and finessing that into this move in the FTSE 100 up to 7,400, down to 7,150 and now back up to 7,300,” he said.
Performance of FTSE 100 over 10yrs
Source: FE Analytics
“We think we are almost by definition nearer the end of the bull market but at the same time I think it is a bull market that has climbed a ‘wall of worry’ – it doesn’t have all the excess signs of real peaking markets,” he added.
“There seems to be more bearishness around in some managers but it equally feels like it might be a little early [for the end of the bull run] so we are just trying to balance the favourable rewards that equities appear to offer (with the yield available and growth in income) to the market straight line we’ve seen since last January.”
Indeed, the FTSE 100 is near record highs having gone through an unprecedented stretch of gains with low volatility at the start of the year.
Despite this, Burdett said: “But we’ve had a 10 per cent correction in world markets every year for the last 10 years and we’re overdue one – it was January last year with the China worries triggering it.”
As the below graph shows, last year the FTSE 100 fell 11.11 per cent from January to mid-February on global concerns that China’s growth was significantly lower than expected.
Performance of FTSE 100 over 1yr
Source: FE Analytics
However, since then it has steadily risen higher and Burdett, despite being positive on the long-term outlook for equities, thinks a market correction is inevitable before the market continue its upward trend.
“I think maybe it is time for a sharp frost to bring on some more spring growth,” the manager said.
As such, he has taken out his first put option in a number of years in order to hedge his slightly overweight position in equities.
A put option gives the buyer the right – but not necessarily the obligation – to sell the underlying security at a fixed price.
Taking out a market put means that if an index falls below the specified price, the buyer will receive more than the current value of the market.
“Since the usage came in in the late 1990s we have been able to use derivatives for efficient portfolio management and I think that is especially suitable for multi-managers because we still like our managers and want to hold them for the long-term,” Burdett said.
“These are short-term concerns that we have hopefully so we tend to short-sell the futures of the appropriate benchmark index or occasionally we might by a put option.
“And the one thing we’ve done is bought a put – which might be the first time we’ve done so for many years – as we’re well aware that volatility is close to all-time lows as measured by the VIX.
“That has meant that the cost of protection has gone down a lot so we can buy a put option very cheaply at the moment and that seems a little more efficient than just short-selling a three-month future because you can longer and you can gear it to a lower cost and a higher pay out.”
The put option he has taken out is on the S&P 500, which has been on an incredibly strong run over the last 10 years thanks to the emergence of the globally-facing, fast-growing technology companies such as the FANG stocks (Facebook, Amazon, Netflix and Google) which are becoming larger parts of the index.
Performance of the S&P 500 and the FTSE 100 over 10yrs
Source: FE Analytics
Indeed, over the last decade the index has returned 188.97 per cent, almost triple (125.9 percentage points more) the returns of the FTSE 100 over the same timeframe.
“It’s an S&P 500 put and it was not only due to the high market levels but because we were underweight the US before Trump got in and we thought ‘we don’t know what’s going on anymore’ and went neutral despite the valuations and so on.
“Luckily that has been the right call but we do feel if market corrections happen anywhere first it could well be the US – it has the most stretched valuations and potential for a bit of disappointment.
“This is because the [most recent] rally that actually started in July in the US but has continued through Trump and the things that people have been justifying it on have not followed through in policy translating into fact so it is an S&P 500 put.”
However, he says he is also considering a put option in the UK, where the FTSE 100 remains at-near record highs if the opportunity presents itself.