What does getting defensive look like for ETF investors facing a pullback?
This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today’s article is co-authored by Anthony Parish, vice president of Research & Portfolio Strategy at Austin, Texas-based Sage Advisory Services, as well as Bob Smith, the firm’s president and chief investment officer.
For equity managers who are mandated to have all or most of their investments in the stock market at all times, their choices for defending against equity corrections are somewhat limited.
But that doesn't mean they’re doomed when equities sell off. The ETF market now offers more choices than ever to help equity investors to get defensive.
We went back in history to see which types of ETFs did the best job defending against corrections in the equities market.
Criteria for inclusion in our study include:
- No fixed-income funds (this includes preferreds and vehicles whose performance is driven by bonds, interest rates and other factors normally found in the domain of fixed income)
- Long only (no shorting)
- No leverage
- Large funds (we set the minimum at $100 million in assets)
This narrowed down the ETF universe to a few basic groups, including real assets such as precious metals and agriculture; defensive equity sectors, such as utilities and staples; currencies, like the dollar, the yen and the Swiss franc; MLPs; as well as some low-volatility strategies such as SPLV, the PowerShares S&P 500 Low Volatility Portfolio (SPLV | A-47).
This left us with a short list of 21 ETFs, though readers could come up with a different list if they used different screening criteria.
We also decided to divide the market corrections into three categories—small, medium and large, which we defined as 5-10 percent; 10-20 percent; and greater than 20 percent sell-offs, respectively.
There were 21 correction periods from 2000 to 2014 though, to be clear, some of the pullbacks were smaller market drops within much larger corrections. For instance, we had a large correction from October 2007 to March 2009, but there were also five smaller corrections within that period. Once we calculated all the returns for each correction, we sorted the mean return for each fund in each correction category.
Of course, the usual caveats apply; namely, just because something worked in the past doesn't guarantee it will work in the future.
Also, not all these ETFs have track records going back to 2000, which means their numbers don’t reflect corrections that occurred in the early years. By commingling young funds and older funds, the process may have penalized those that experienced all of the correction periods—mainly MLPs and precious metals. See the table below for specific performance numbers.