How to hedge your portfolio in a bear market.
The last time the stock market truly crashed was in March 2020 at the height of the COVID-19 pandemic. During that time, equities sold off sharply, leading to a rapid and unanticipated drop in notable stock market indexes like the S&P 500, Nasdaq and Russell 2000. Today, investors are on edge anticipating the next crash. A host of factors like high inflation, rising rates and stocks dipping into bear market territory have contributed to a strong risk-off attitude. Investors interested in hedging their portfolios can use a variety of instruments to do so, such as put options, VIX futures and Treasurys. These assets generally possess a low-to-negative correlation with stocks and high volatility, making them possible diversifiers in trying times. Here is a list of seven exchange-traded funds, or ETFs, that are built with a degree of crash protection in mind.
Amplify BlackSwan Growth & Treasury Core ETF (ticker: SWAN)
SWAN was designed with the intention of mitigating “black swan” events. These are unforeseen, catastrophic events that cause significant losses for investors. Examples include COVID-19, 9-11, and the 2008 subprime mortgage crisis. SWAN is designed to offer exposure to 70% of the S&P 500 and 90% of intermediate U.S. Treasurys in one convenient package. The ETF does this by holding 90% of its capital in Treasurys, while investing the remaining 10% in long-term equity appreciation securities (LEAPS) call options, which provides leverage equal to holding a 70% allocation in the S&P 500. The theory is that during bad crashes, the “flight to safety” effect and cuts in interest rates by the Federal Reserve will cause the price of Treasurys to soar, which can offset stock losses. During bull markets, the S&P 500 LEAPS mimics holding the index. SWAN costs an expense ratio of 0.49%.
WisdomTree U.S. Efficient Core Fund (NTSX)
NTSX follows the same philosophy as SWAN: package stocks and Treasurys into a convenient single-ticker solution. However, the fund differs in its allocations and construction. NTSX currently holds 90% of its capital in the S&P 500, with the remaining 10% in cash as collateral for futures contracts that act as a 60% Treasury allocation. Effectively, NTSX is a traditional “balanced” 60/40 portfolio with 1.5x leverage applied, which historically has offered a great risk-return profile. Investors who hold 67% NTSX therefore gain the benefits of a 60/40 portfolio and have another 33% to allocate toward additional diversifiers. During a crash, the 60% Treasury exposure may help offset losses in the same way that SWAN does. NTSX is also extremely tax efficient thanks to the use of futures on the fixed-income side. Best of all, the ETF is fairly cheap compared with others on this list, with an expense ratio of 0.20%.
Simplify U.S. Equity PLUS Downside Convexity ETF (SPD)
SPD comprises just two holdings. The first is the S&P 500, which accounts for around 96% of the ETF. The remaining 4% is invested in a ladder of out-of-the-money, or OTM, put options. During a bad crash, these put options can soar in value, which can offset the losses in the S&P 500. However, during bull markets, SPD will likely trail a vanilla S&P 500 index fund due to the cost of buying new put options continuously. Simplify attempts to mitigate this by purchasing near-expiry OTM puts, which are generally cheaper and possess greater convexity (i.e., better payouts during a crash). For investors looking to hedge with options but not willing to trade options themselves, SPD can be a great one-ticker managed solution. The ETF costs an expense ratio of 0.28%.
Cambria Tail Risk ETF (TAIL)
Like SPD, TAIL also allocates a portion of its capital — in this case, about 20% — to a ladder of OTM puts on the S&P 500. The remaining 80% of the ETF is allocated toward U.S. Treasurys and Treasury Inflation-Protected Securities. This provides the ETF with more stability and helps fund the premiums for the OTM puts via the coupon interest paid. TAIL can be envisioned as insurance. During normal market conditions, the fund can be expected to lose value slowly as the put options are rolled over in the process of selling them and buying new ones. However, during a crash the put options can spike in value, which causes TAIL to appreciate rapidly. Investors can therefore use TAIL to substitute part of their bond portion, especially in a rising rate environment. TAIL costs an expense ratio of 0.59%.
ProShares Ultra VIX Short-Term Futures ETF (UVXY)
The Chicago Board of Options Exchange Volatility Index, or VIX, is colloquially known as Wall Street’s “fear gauge.” The VIX is calculated according to the market’s expectations of implied volatility based on S&P 500 options. Generally, when markets decline or crash violently, volatility spikes and the VIX goes up. Investors can’t buy the VIX directly, but can gain exposure via VIX futures contracts, which are derivatives that bet on the potential future value of the VIX. UVXY provides this exposure in ETF form with 1.5 times leverage by holding a ladder of short-term VIX futures contracts. This fund has a strong negative correlation to stocks, spikes sharply during crashes, but does decay in price over time. This makes it more suitable as a short-term, tactical holding as opposed to a long-term hedge. UVXY costs an expense ratio of 0.95%.
ProShares UltraPro Short QQQ (SQQQ)
The large-cap growth stocks of the tech-heavy Nasdaq 100 have been hit hard throughout 2022, with the index still down over 20% from its all-time high through late June. Despite the sell-off, some are anticipating further downsides given recent tech-sector layoffs and future anticipated rate hikes. Investors looking to hedge against a potential crash in the Nasdaq-100 can buy SQQQ, which offers daily three times leveraged inverse performance. The key word here is “daily.” Due to how compounding works, holding SQQQ for longer periods of time may result in unpredictable returns. Like UVXY, holding SQQQ long term is not recommended as the ETF suffers from significant volatility decay, causing its share price to lose value if held for too long. SQQQ is also fairly expensive, costing an expense ratio of 0.95%.
Nationwide Nasdaq-100 Risk-Managed Income ETF (NUSI)
NUSI offers income-oriented investors a high-yield, lower-volatility investment through its use of a collar strategy on the Nasdaq-100 index. This is an options strategy that involves selling a covered call and uses some of the premiums received to finance a ladder of OTM puts. This strategy effectively limits both the upside return and downside risk of the ETF, allowing for more predictable and less volatile performance, along with enhanced income from the remaining covered call premiums. In a bull market, NUSI will underperform, but the ETF may pull ahead in sideways or bear markets. During a crash, the put options can increase in value, which can offset losses somewhat. Currently, NUSI pays a yield of 7.5% and costs an expense ratio of 0.68%.
7 top ETFs to hedge against a stock market crash:
— Amplify BlackSwan Growth & Treasury Core ETF (SWAN)
— WisdomTree U.S. Efficient Core Fund (NTSX)
— Simplify U.S. Equity PLUS Downside Convexity ETF (SPD)
— Cambria Tail Risk ETF (TAIL)
— ProShares Ultra VIX Short-Term Futures ETF (UVXY)
— ProShares UltraPro Short QQQ (SQQQ)
— Nationwide Nasdaq-100 Risk-Managed Income ETF (NUSI)
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7 ETFs to Hedge Against a Stock Market Crash originally appeared on usnews.com
