9 Defensive ETFs for a Volatile Market

These exchange-traded funds can help investors looking to play defense.

Markets remain highly volatile in the second half of 2022. After the first half saw the S&P 500 and Nasdaq 100 indexes each draw down more than 20% to enter bear markets, a brief rally ensued in July that saw both post modest recoveries. Hopes for a long-term reversal were dashed on Sept. 13 when the latest consumer price index release showed inflation rising 8.3% year over year in August, surpassing consensus market expectations of 8.1%. Stocks quickly sold off, with investors seeing the writing on the wall for another aggressive interest rate hike from the Federal Reserve on Sept. 21, a fear that materialized when the Fed raised rates by 75 basis points. Year to date through Sept. 21, the closely watched CBOE Volatility Index is up 62.5%. Investors looking to minimize fluctuations in their portfolio can consider these nine defensive exchange-traded funds, or ETFs, to protect against a volatile market.

SPDR Bloomberg 1-3 Month T-Bill ETF (ticker: BIL)

Bonds provided investors protection for over 40 years as interest rates generally trended lower. During this time, bonds experienced a strong bull market, with long-term Treasurys in particular providing crash protection during the 2000 dot-com bubble, the global financial crisis of 2007-2009 and the 2020 COVID-19 crash. However, this reversed in 2022, when rising interest rates and soaring inflation sent yields higher, which tanked the price of longer-duration bonds. Investors looking to immunize their portfolio against interest rate risk can consider ultrashort-duration Treasury bills. A great ETF to hold here is BIL, which tracks the Bloomberg 1-3 Month U.S. Treasury Bill Index. BIL has an average duration of 0.16 year, meaning that it would lose just 0.16% if interest rates rose by 1%. The ETF costs an expense ratio of 0.13%, or about $13 annually for a $10,000 investment.

iShares 0-3 Month Treasury Bond ETF (SGOV)

A great alternative to BIL is SGOV. Like BIL, SGOV also tracks an index of ultrashort-duration U.S. Treasury bills. In this case, SGOV holds Treasury bills with three or fewer months until expiry. Compared to BIL, SGOV has a slightly lower average duration of 0.12 year, meaning that it would lose just 0.12% if interest rates rose by 1%. A great use for SGOV is as a tax-loss harvesting partner for BIL, given that they both perform similarly yet track different indexes. SGOV usually costs an expense ratio of 0.12%, but that has been waived to just 0.05% until at least June 2023.

Vanguard Short-Term Treasury ETF (VGSH)

Investors who don’t mind taking on slightly greater interest rate risk in return for higher yields can opt for a short-term treasury ETF like VGSH. This ETF has a duration of 1.9 years, meaning that if interest rates rise by 1%, VGSH is likely to lose around 1.9%. While higher than BIL or SGOV, VGSH makes up for it with a better yield to maturity of 3.5% as of right now. The ETF is a favorite of investors trying to replicate Warren Buffett’s famous 90/10 portfolio of the S&P 500 plus short-term Treasury bills. VGSH costs an expense ratio of 0.04%.

Vanguard Short-Term Inflation-Protected Securities ETF (VTIP)

Inflation tends to wreak havoc on most fixed-income assets as their yields can no longer keep up with its value-eroding effects. The exception here are the Treasury’s inflation-protected securities, or TIPS. The price of TIPS is indexed to inflation. If inflation surges unexpectedly, the face value and coupon payments for TIPS will increase. All else being equal, this helps TIPS maintain purchasing power during inflationary conditions. However, TIPS are still bonds, and that makes them sensitive to rising interest rates. A great option here is VTIP, which holds a portfolio of TIPS that have an average duration of 2.7 years. The shorter duration gives better protection against rising rates. VTIP costs an expense ratio of 0.04%.

WisdomTree U.S. Efficient Core Fund (NTSX)

NTSX is an interesting ETF that offers capital efficiency via the use of leverage. For every $100 invested in NTSX, the fund manager allocates 90% toward large-cap U.S. stocks. The remaining $10 is held as cash collateral for futures contracts on U.S. intermediate Treasury bonds, which gives six times leverage. Thus, the ETF’s exposure can be described as 90/60 stocks and bonds, or a traditional 60/40 portfolio on 1.5 times leverage. Investors can therefore hold 67% NTSX in their portfolio to gain the risk/return profile of a 60/40 portfolio, while allocating the remaining 33% to additional diversifiers with a low correlation to stocks and bonds to reduce volatility further. This can include cash, commodities and other alternative investments. NTSX costs an expense ratio of 0.2%.

Amplify BlackSwan Growth & Treasury Core ETF (SWAN)

SWAN is built along the same principles as NTSX: Package stocks and bonds into a single ticker and apply leverage. For every $100 invested in SWAN, 90% is invested in 10-year U.S. Treasurys. The remaining 10% goes into long-term equity anticipation securities, or LEAPS, which are long-dated call options on the S&P 500 targeting 70% exposure. Thus, the ETF’s exposure can be described as 70/90 stocks and bonds. SWAN can be used along the same lines of NTSX, as it has roughly the same risk-return profile at a slightly more conservative allocation. However, it does cost a higher expense ratio of 0.49%.

Simplify U.S. Equity PLUS Downside Convexity ETF (SPD)

The problem with NTSX and SWAN is their reliance on Treasury bonds. During periods of rising rates and inflation, stock-bond correlations can turn positive as the latter drops in tandem with the former. This causes bonds to lose much of their diversification value and protective capabilities. SPD remedies this by investing 96% of its assets in the S&P 500, while reserving 4% for a ladder of out-of-the-money, or OTM, put options. These options possess greater convexity, meaning that their value can soar greatly during a bad crash. This can offset the overall ETF’s losses. However, during bull markets SPD is likely to lag due to the cost of buying the put options. Think of them as insurance you have to pay a periodic premium for. SPD costs an expense ratio of 0.28%.

Cambria Tail Risk ETF (TAIL)

Like SPD, TAIL also makes use of a ladder of OTM put options. In this case, around 20% of the ETF is allocated to OTM put options with varying strike prices and expiry dates. The remaining 80% of the ETF is invested in a mixture of U.S. Treasurys and TIPS. The coupon payments from the bonds help provide yield to finance the premiums required for the OTM put options. Over long periods of time, TAIL does lose value slowly as the market trends upward. This is because its OTM put options continually expire with no value and have to be repurchased or rolled forward at a cost. However, during a bad crash TAIL can spike strongly higher, as it did during the COVID-19 crash of March 2020. TAIL costs an expense ratio of 0.59%.

Nationwide Nasdaq-100 Risk-Managed Income ETF (NUSI)

Investors looking to insulate their portfolio from massive fluctuations while still earning a competitive yield can use NUSI. This ETF deploys an options collar strategy on the Nasdaq 100 index. NUSI sells a covered call, for which it receives a cash premium. It then uses a portion of this premium to pay for a protective put, and the remainder gets paid out to the investor as a monthly yield. By doing so, NUSI caps both upside and downside potential, making it a good option for investors who prefer stability over total returns. The ETF lags during bull markets but can outperform during sideways and bear markets. Currently, NUSI pays a 12-month-trailing yield of 9.3% and costs an expense ratio of 0.68%.

9 defensive ETFs to buy for a volatile market:

— SPDR Bloomberg 1-3 Month T-Bill ETF (BIL)

— iShares 0-3 Month Treasury Bond ETF (SGOV)

— Vanguard Short-Term Treasury ETF (VGSH)

— Vanguard Short-Term Inflation-Protected Securities ETF (VTIP)

— WisdomTree U.S. Efficient Core Fund (NTSX)

— Amplify BlackSwan Growth & Treasury Core ETF (SWAN)

— Simplify U.S. Equity PLUS Downside Convexity ETF (SPD)

— Cambria Tail Risk ETF (TAIL)

— Nationwide Nasdaq-100 Risk-Managed Income ETF (NUSI)

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9 Defensive ETFs for a Volatile Market originally appeared on usnews.com

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