Volatility has been at the forefront over the past weeks amid escalating trade worries and concerns over a slowing economy. The S&P 500 has shed more than $5 trillion in value in the three weeks from its peak on Feb. 19.
In such a scenario, investors should apply some hedging techniques to their equity portfolio to reduce the overall volatility or protect against significant market downturns. While there are a number of ways to do this, volatility-hedged ETFs seem compelling choices. Some of these include Global X S&P 500 Covered Call ETF XYLD, iMGP DBi Managed Futures Strategy ETF DBMF, FT Vest Laddered Buffer ETF BUFR, Invesco S&P 500 Downside Hedged ETF PHDG and Simplify Hedged Equity ETF HEQT.
Investors should note that these funds have the potential to stand out and outperform simple vanilla funds in case of rising volatility (read: Ride Out the Market Storm with Low-Volatility ETF Strategies).
Volatility-hedged ETFs are investment products designed to mitigate the impact of market volatility on a portfolio. These ETFs typically aim to provide investors with exposure to a particular asset class or market while reducing the impact of price fluctuations resulting from market volatility.
The basic premise behind volatility-hedged ETFs is to combine a long position in an underlying asset or market with a short position in volatility futures or options contracts. By shorting volatility, these ETFs attempt to offset or “hedge” the potential losses that may occur during periods of heightened market volatility.
These ETFs are often structured to provide targeted exposure to specific markets, such as equities or fixed income while attempting to reduce the impact of volatility on returns. They may employ various strategies and techniques, including options, futures contracts, and other derivatives, to achieve their objective.
However, these ETFs may not always provide complete protection during extreme market events, and they may have additional costs associated with their hedging strategies.
President Donald Trump’s trade affairs are likely to increase prices for U.S. consumers and will hamper domestic economic growth. The barrage of recent data related to surveys and sentiment indicators points to a downturn in the economy. U.S. consumer sentiment in March fell for the third consecutive month. Although inflation was softer than expected in February, many analysts believe that the relief is temporary (read: 3 Sector ETFs That Drove Inflation in February).
Additionally, recession fears were amplified last week after comments from Trump regarding a “period of transition” for the U.S. economy. Traders are now pricing in the possibility that the Fed will cut interest rates several times this year amid a tariff-driven U.S. economic slowdown, signs of a cooling labor market and softer inflation.
Many Wall Street analysts have raised concerns about stagflation, wherein growth stagnates, inflation remains high and unemployment rises.
Global X S&P 500 Covered Call ETF (XYLD)
Global X S&P 500 Covered Call ETF seeks to generate income through covered call writing, which historically produces higher yields in periods of volatility. It buys stocks in the S&P 500 Index and “writes” or “sells” corresponding call options on the same index. XYLD tracks the Cboe S&P 500 BuyWrite Index, charging 60 bps in fees per year.
Global X S&P 500 Covered Call ETF has amassed $3.1 billion in its asset base and trades in a good volume of 735,000 shares.
iMGP DBi Managed Futures Strategy ETF (DBMF)
iMGP DBi Managed Futures Strategy ETF seeks long-term capital appreciation. It will employ long and short positions in derivatives, primarily futures contracts and forward contracts, across the broad asset classes of equities, fixed income, currencies and commodities.
iMGP DBi Managed Futures Strategy ETF has AUM of $1.1 billion and charges 85 bps in annual fees. It trades in a moderate volume of 947,000 shares a day on average.
FT Vest Laddered Buffer ETF (BUFR)
FT Vest Laddered Buffer ETF seeks to achieve its investment objective by providing investors with US large-cap equity market exposure while limiting downside risk through a laddered portfolio of Target Outcome ETFs. These ETFs use an options strategy that seeks to provide a 10% downside buffer with upside potential, up to a predetermined cap, based on the price return of SPDR S&P 500 ETF Trust (SPY), for a Target Outcome Period of approximately one year.
FT Vest Laddered Buffer ETF has AUM of $6.4 billion and trades in an average daily volume of $1.3 million shares. It charges 95 bps in annual fees.
Invesco S&P 500 Downside Hedged ETF (PHDG)
Invesco S&P 500 Downside Hedged ETF is an actively managed fund that seeks to deliver positive returns in rising or falling markets that are not directly correlated to broad equity or fixed-income market returns. It tries to follow the S&P 500 Dynamic VEQTOR Index, which provides broad equity market exposure with an implied volatility hedge by dynamically allocating between different asset classes: equity, volatility and cash. The index allows investors to receive exposure to the equity and volatility of the S&P 500 Index in a dynamic framework.
Invesco S&P 500 Downside Hedged ETF has accumulated $114.7 million in its asset base and charges 39 bps in fees per year from its investors. Volume is good, exchanging 19,000 shares a day on average.
Simplify Hedged Equity ETF (HEQT)
Simplify Hedged Equity ETF seeks to provide capital appreciation by offering U.S. large-cap exposure while investing in a series of put-spread collars designed to help reduce volatility. By deploying a ladder of collars that expire over three sequential months, the fund seeks to create a hedged equity experience that is also robust to rebalancing luck (read: Low-Beta ETFs to Hedge Against Trade War Risks).
With an AUM of $401.1 million, Simplify Hedged Equity ETF charges 44 bps in annual fees and trades in an average daily volume of 158,000 shares.
Investors can shield their portfolios against volatility with the help of the abovementioned products. These provide dynamic exposure according to the level of market volatility and are least affected by any market turmoil. So, they could prove to be great choices when it comes to offering protection against market downturns.
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Invesco S&P 500 Downside Hedged ETF (PHDG): ETF Research Reports
Simplify Hedged Equity ETF (HEQT): ETF Research Reports
This article originally published on Zacks Investment Research (zacks.com).
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