Can I Hedge That With an ETF? Probably

These are not our parents’ investment markets. 

Not when we can see the Nasdaq go in one direction, the S&P 500 get pulled in that same direction because it overlaps so much with the Nasdaq, and much of the global stock market not following along. 

This makes for a most confusing time for investors, and, as a lot of our politics have become, two people can look at the same headline and draw completely different interpretations.

When we see “stock market hits all-time highs,” that’s not the whole stock market the headlines are talking about. It is the biggest and most popular stocks, such as those contained the Invesco QQQ Trust ETF (QQQ) and the SPDR S&P 500 Trust ETF (SPY). International and emerging market stock indexes, as well as US small caps and high dividend stocks are between 10% and 30% or more off their own all-time highs, depending on which of many index ETFs we inspect.

Hedge Portfolios with ETFs

One issue I've been researching in my own investing this year is how to efficiently and effectively hedge portfolios against steep declines in parts of the global stock market, at a time when the “market” according to the standard definition (SPY, QQQ, etc.) is doing so well. This is an issue for any investor that has a substantial amount of assets in a portfolio that does not skew heavily toward those indexes.  

This is not only for hedging purposes. Some investors may read what I report below and decide that they want to try to exploit potential declines in less popular parts of the stock market and learn more about how these inverse ETFs might help them pursue that objective. 

While there are scores of ETFs that essentially short parts of the market but use leverage to do so, these are single inverse ETFs, not levered ones.

Sneaky, Effective Ways to Hedge

The real estate sector could end up in the crosshairs of the next financial crisis. If so, the $17.8 million ProShares Short Real Estate ETF (REK) might surge to the top of the leader board.  

Many investors are familiar with inverse ETFs that short the Russell 2000 small cap index. However, the $5.9 million ProShares Short SmallCap600 ETF (SBB) is the only ETF that seeks to profit in an unlevered structure from a decline in the other prominent small cap index.  

REK has been around for more than 15 years, and SBB debuted nearly 18 years ago. So, these are not new kids on the block, and obviously most of their tenure has been characterized by negative returns. But this is the nature of inverse ETF investing. They do not buy and hold vehicles. They are loss-preventers. Thus, it may help some investors to have them on their watchlists, or at least in their memory banks.

Inverse, and Quirky

And perhaps one of the smallest, quirkiest inverse ETFs out there, the ProShares Decline of the Retail Store ETF (EMTY), at $4.3 million, may not be on the tip of many investors’ tongues. But by essentially delivering the short side of the Solactive-ProShares Bricks and Mortar Retail Store Index, if the continued trend toward online shopping and away from in-person buying continues, there’s a path to profits here.

Maybe these tiny, against-the-grain ETFs are not going to carry anyone to long-term investment success. But it is worth noting that during the first nine months of 2022, the S&P 500 fell 24%, while REK, SBB, and EMTY produced gains of 35%, 25% and 16% over that time, for an average outperformance of 49%. In just nine months! Therein lies the occasional, yet viable role of single inverse ETFs for investors who decide that a little hedging can go a long way.