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For Emerging Market Gains, Limit Risks

NEW YORK ( TheStreet) -- Since May 9, 2009, I have suggested that investors bet against the dollar by purchasing mutual funds and exchange traded funds in Africa, Latin America and Asia. As I reported in a recent article, these investments have done well:

Was I lucky? I don't like to think so: I made strong economic arguments for these investments. And even with their price run ups, I plan to stick with them. Why? Because I believe these regions will be the growth engines of the 21st century and the dollar will weaken further.

Long positions:

But there is one thing that bothers me: I have long positions in all these investments with no protection. At this point, I would settle for lower returns if I could somehow reduce the downside risk.

What do I know about limiting downside risk? Not much. Sure, I have heard about hedging, puts, calls, etc., but I thought I could learn a lot more by talking to someone who is a real professional at limiting risk.

Matt Lenehan earned an MBA from the Tuck School of Business at Dartmouth. He received the Chartered Alternative Investment Analyst (CAIA) professional designation for "alternative" asset classes, including real estate, private equity and hedge funds. Matt invested endowment funds at Dartmouth before co-founding Newport Investment Management with two partners. Like endowments, Newport worries a lot about downside risk.

Elliott: First, I want your opinion -- do you think I've just been lucky?

Matt: No. As the following table indicates, your holdings compare favorably against a representative basket of broad and BRIC-centric exposure. As compared to a 75%/25% blend of Vanguard Emerging Markets ETF (VWO) and SPDR S&P BRIC 40 ETF (BIK), your portfolio has significantly outperformed portfolios with comparable risk. This more than justifies the higher expense of using some active investing by mutual fund managers.

Reducing risk:

Elliott: Why is limiting risk such a focus? And what do you do at Newport to limit risks?

Matt: Endowments got hit hard by losses resulting from the U.S. banking collapse. Investments with equity exposure, whether publicly traded or through private partnerships, contributed to 19% average endowment losses for the year ended June 2009 (Per 2009 NACUBO-Commonfund Study of Endowments Top endowments like Harvard and Yale lost 25%-plus. As a result, many boards revisited risk and now see that allocations to hedge funds, which can short and still lost 12% in the same year, are not enough.
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