Downside Risk ETFs Get Their Moment

Equity ETFs that rely on VIX derivatives to hedge downside risk yield a surprising range of results.

Senior ETF Specialist
Reviewed by: Paul Britt
Edited by: Paul Britt

Equity ETFs that rely on VIX derivatives to hedge downside risk yield a surprising range of results.

Today continues a crimson-tinged trend: Another day of extreme market volatility in the downward direction after a long period of relative tranquility.

This drama got me wondering about the small batch of equity funds specifically designed to weather such storms by profiting from volatility.

These ETFs use futures or options on the CBOE volatility index, known as the VIX index or simply as the fear index. By incorporating VIX exposure via derivatives—a tool set that’s notoriously hard to handle—the ETFs aim to provide downside protection from sharp downturns like those we’ve seen recently, while maintaining broad equity exposure.

Before we look at the short-term performance of these funds, let’s check what the VIX index itself has been doing since the start of September against the S&P 500 and a leading VIX-based fund.


It’s up more than 85 percent. Sadly, the fear index is uninvestable. The next best thing for direct access to this high-octane contrarian is the iPath S&P 500 VIX Short-Term Futures ETN (VXX | A-47). VXX is up about 34 percent for the same period—a nice counterpoint the S&P 500 Index’s 6 percent drop.

VXX uses derivatives to access the VIX, just as the tail-risk-hedged ETFs do. The key difference is that the tail-risk-hedged products also have baseline exposure to equities and use a VIX derivatives overlay to get upside from any downdraft.


Tail-Risk-Hedged ETFs Since Sept. 1

Given this construction, let’s see if the tail-risk-hedged funds are ready for their close-up in the face of sharp volatility compared with the SPDR S&P 500 (SPY | A-97).

Tail Risk since sept 1

Two immediate observations: First, none of the funds is actually up for the period. VIX-based hedging is extremely expensive to maintain in the long run, so the funds mete out their exposure sparingly.

Second, there’s both dispersion and overlap in the chart. The dispersion comes from the differing approaches from fund to fund with respect to their VIX-derivative component. The overlap is expected in one case but not the other. I’ll explain.

Leading the pack is the first example of overlapping performance, set by the Barclays S&P Veqtor ETN (VQT | B-50) and the PowerShares S&P 500 Downside Hedged ETF (PHDG | A-50). With SPY down 6 percent since Sept. 1, this pair of funds is only down 1.1 percent. I’d consider this a success in the short run. They share the same performance because they essentially track the same index.

Next comes a pair of sister funds, the VelocityShares Tail Risk Hedged Large Cap ETF (TRSK | C-64) and the VelocityShares Volatility Hedged Large Cap ETF (SPXH | C-79). TRSK is down 3.4 percent and SPXH is down 5.1 percent.

These funds take offsetting positions (both long and short) in VIX derivatives in an attempt to mitigate the high holding costs. The downside of this approach is that they give up some short-run protection. SPXH has greater offsetting exposure, explaining why it lags TRSK.

At once disappointing and puzzling, the First Trust CBOE S&P 500 VIX Tail Hedge ETF (VIXH | D-84) manages to lag SPY slightly, down 6.1 percent to SPY’s 6.0 percent. The fund’s performance suffers perhaps because its hedging mojo is set by absolute levels of the VIX, which had been near historic lows.


The Long(er) Run

While built to endure the market’s recent volatility, this group of funds is designed for the long haul. A year-to-date snapshot shows how well the funds maintain equity upside as SPY has eked out about 3 percent in total return through Oct. 14. The standouts here are once again VQT and PHDG, with 2.5 percent and 2.8 percent, respectively. PHDG’s edge over its peer is likely due to its far lower fee. Lagging—again—is VIXH, turning in 0.4 percent for the year.

Tail Risk YTD

I remain skeptical of these strategies: The cost of insurance via VIX derivatives outweighs the benefits.

Still, based on these performance snapshots, PHDG stand out as delivering a measure of downside protection in tough times while maintaining some equity upside. One massive caveat: The fund significantly lagged SPY in 2013’s joyride, turning in 13 percent to SPY’s 32 percent. That’s the real cost of insurance.

In contrast, VIXH doesn’t look ready for its 15 minutes of fame, turning in the weakest performance since Sept. 1 and year-to-date.



At the time this article was written, the author had no positions in the securities mentioned. Contact Paul Britt at [email protected].


Paul Britt, CFA, is a senior analyst in the ETF Analytics group at FactSet, a team that maintains and develops an industry-leading suite of ETF-related data and analytics products. Prior to joining FactSet in April 2015, he was a senior analyst at, where he performed a similar role, and worked in private placement at Pensco Trust. Paul holds a B.S. from RIT and an M.S. in financial analysis from the University of San Francisco.