Five Ways Hedge Funds Brace for a Stock Market Crash, and You Can Too

Investors almost always worry about a stock market crash, but when headwinds start to look stronger than the positive forces, they really start to worry that the rug can get yanked right out from under them. Perhaps what retail investors should do is try to learn what the professionals do with their clients’ money and their own money. Very few fund managers sell out of stocks entirely. After all, cash never rallies, and it is widely known that bull markets always seem to crawl a wall of worry.

24/7 Wall St. is identifying and discussing several strategies that investment managers, hedge funds and market gurus use to keep their toes in the stock market but manage to avoid major risk of a stock market crash. Performance and assets under management are everything to the hedge funds and institutional money managers, because their asset base and their performance are how they get paid. Now that the 2% management fee and 20% performance fee structure has been changing, these managers have to guard against too much risk leading to too high of losses.

Even after a summer pullback, the stock market performance of 2013 was better than most fund managers have seen in a decade or more. The last thing that a portfolio manager wants is to see a stock market crash rob them of their strong performance. Imagine trying to explain to clients how you wanted more upside even after stocks have more than doubled from the lows of 2009, even with all the warning signs that were evident in August of 2013.

24/7 Wall St. looked at five different strategies that many of the top hedge funds and institutional money managers may use to prevent a total wipeout of their performance. These strategies do not have any significant barriers to entry. Frankly, they can be used rather easily by any cautious investor.

These strategies include writing call options or buying put options, as well as shorting exchange traded funds (ETFs) and futures. We have of course discussed the method of gradually selling out of profitable positions rather than selling the whole boat, and there is the method of simply rotating into defensive shares. These are all discussed in detail, with examples for clarity.

St. Jude Up 3% As Fitch Affirms Ratings, FDA Sets Date

Medical device maker St. Jude got a lift Friday for two reasons: Fitch Ratings maintained the company’s debt ratings and the FDA set an October 9 date for a review that could result in approval of a new heart device.

Shares of St. Jude Medical (STJ), best known for its implantable heart defibrillators, were up $1.70, or more than 3.%, to $52.66.

Fitch reiterated its bond ratings and said that President Barack Obama's health-care overhaul should modestly improve volume growth for St. Jude’s products as more people get health insurance over the next two years, according to MarketWatch in this report.

The reiteration on debt and the safety of leverage levels is important with discussion of the device, the CardioMEMs’ Champion Heart Failure Monitoring System, back on the calendar. St. Jude has a 19% stake in CardioMEMs and the option for an outright purchase. While the FDA date announcement was news, this is a review “yet again” of the monitoring system for FDA approval, write Leerink Swann Research Analysts Danielle Antalffy and Robert Marcus

They added in a note this morning that: 

“The CardioMEMs’ system was rejected by an FDA panel in December 2011 based on concerns over device labeling and efficacy. In 1Q13, St. Jude … recently ramped its interest in the company with a $28M debt financing based on what appears to be favorable due diligence. CardioMEMs is a potential $1B + market opportunity, which would represent meaningful upside to our current long-term (2012-2016) St. Jude sales and earnings per share growth projections of 3% and 7%. We view today’s announcement positively, with the likelihood for ultimate approval of CardioMEMs — previously viewed as ‘dead in the water’ — now significantly higher.”

Antalffy and Marcus have an Outperform rating on St. Jude stock and a 12-month price target of $56. That is based on a multiple of 14 times the Leerink estimate of for 2014 earnings of $3.99 per share. That is slightly above the 13.5 times multiple of heart-related competitors but below the large-cap medical technology group average of 15.3 times, they write.

Colleague Dave Englander recommended taking profits in another medical device maker, Boston Scientific (BSX) in mid-August. At the time, he noted that stock was up 107% since his favorable recommendation had appeared, outpacing the Standard & Poor’s 500 Index by 80 points. He noted Boston Scientific faces competition from St. Jude and Medtronic (MDC), and he said that the market for stents and defibrillators has stabilized but is “not likely to grow meaningfully.”  (See “Time to Sell These Winners,” Aug. 14, subscription required.)