By Andrey Dashkov, analyst, Casey Research
Would you take investing advice from someone who lost 5% over the past 12 months?
While that number isn’t impressive – nobody likes losing money – this result is much better than those of stocks and bonds.
Since October 2021, stocks are down 15.5% and bonds by 17.2%.
(I’m talking about the S&P 500 Index as a proxy for the stock market and the iShares Core U.S. Aggregate Bond ETF for bonds.)
Meanwhile, the asset class that lost just 5% is hedge funds.
And they are doing something that you should, too.
It will save you from possible future losses and help you accumulate available capital when it’s time to start buying again.
Hedge Funds Are Reducing Leverage
Bloomberg reports that hedge funds have started slashing their leverage.
As a reminder, leverage means borrowed money. Institutions borrow money to increase their returns…
…But only if things work out as planned. If they use leverage and the market turns against them, their losses could add up to more than 100%.
In other words, in addition to their positions being wiped out, they’d also need to pay back debt.
This is why hedge funds, or the “smart money,” are driving down their leverage.
Net leverage, which is calculated based on long and short positions, has fallen to a level of 41%, according to Morgan Stanley.
This is one of the lowest levels in about 10 years.
Right now, it looks like “smart money” is taking a defensive position. And you should, too.
If you’ve ever borrowed money to put into stocks, especially high-risk tech plays or other speculative investments, it’s time to reconsider that strategy.
This Hidden Leverage Could Kill Your Stock Returns
Even if you’ve never borrowed to invest, you could still be holding high-leverage positions.
For example, you might’ve put your money into stocks with a lot of debt on their books.
If companies don’t make enough money to pay the interest on their debt, they are considered “zombie” companies.
Some estimates point out that about 13% of companies based in the U.S. fall into this category.
To find out if you hold any of them, you could look at their interest coverage ratios, which are calculated by dividing a company’s earnings before interest and taxes (EBIT) by its interest expense during a given period.
A ratio below one signals that you could be looking at a “living dead” company.
In this market environment, it’s better to ditch the high-risk plays and turn to safer bets…
A Better Way to Invest This Year
Instead of increasing risk, this year, “smart money” is looking for income-paying stocks.
Which makes sense.
Income-focused investments such as dividend-paying stocks are profitable and more stable than their high-flying counterparts.
With interest rates rising, investors also have more options to receive income from fixed-rate investments, such as treasuries or corporate bonds.
There are risks, though – even with this strategy.
Rising interest rates work against the value of bonds or bond-like investments.
So the best way to invest in 2022 and early 2023 is through safe dividend yields.
This is exactly what Casey Research colleague Brad Thomas – income investing expert and editor of the Intelligent Income Investor advisory – is doing.
He’s found companies that have paid reliably increasing dividends for well over a decade. And he seeks out strong companies with solid fundamentals and wide moats that will provide investors with predictable, passive income over the long term.
For a full list of his favorite dividend-paying stocks, and to learn more about how you can access his research, go here.
I highly recommend that you consider Brad’s analysis and recommendations.
Analyst, Casey Research