The U.S. equity market has had a bumpy start in 2019, coming off a year when both the S&P 500 and longer-dated Treasuries (as measured by the iShares 20+ Year Treasury Bond ETF (TLT)) ended in the red. It’s no wonder asset managers everywhere are calling for some defensive investing.
De-risking a portfolio can be done in many ways, and traditionally, it has involved lightening up on some of your equity exposure, and adding in some high-grade bonds for safety—think huge funds like TLT or the iShares Core U.S. Aggregate Bond ETF (AGG).
But some are saying this year that playing defense in today’s market environment may require more creative thinking than simply upping your bond allocation due to correlations. To quote VanEck’s CEO Jan van Eck, there’s been an “interesting change” in the correlation between stocks and bonds.
“This correlation has started to trend upwards,” he said in his recent market outlook. “This means that using long-duration bonds as a shock absorber or hedge in a portfolio may become more difficult. Investors may need to look elsewhere for defensive positioning against equity risk.”
(To see van Eck’s full outlook, click here.)
Where To Look?
You can play equity defense with equity ETFs. VanEck’s specific picks include funds such as the VanEck Vectors Real Asset Allocation ETF (RAAX), the VanEck Vectors Gold Miners ETF (GDX) and the VanEck Vectors NDR CMG Long/Flat Allocation ETF (LFEQ).
Here are some other ideas:
Innovator has been rolling out a series of what it calls “Buffer ETFs” every quarter since last summer. These funds, such as the Innovator S&P 500 Ultra Buffer ETF – October (UOCT), are actively managed portfolios that track the price return of the S&P 500, but cap gains on the upside and protect from losses on the downside over a one-year period.
Each ETF in this series has its own range of built-in protection and upside limit, and that range—which is set at launch—changes every day depending on market action. The portfolios comprise custom S&P 500 FLEX options that vary in strike price, but that share the same expiration date. They reset annually.
UOCT, for instance, at launch offered a 15% upside cap limit, and downside protection of 5-35% if the S&P 500 drops. Given price performance since its launch in October—the S&P 500 is down—UOCT offers today about 24% of additional room in the downside.
The math isn’t very intuitive, for sure, but Innovator allows investors to calculate their buffers every day on its website.
These funds essentially allow investors to own the S&P 500, but mitigate some of the uncertainty that’s associated with equity investing. You may give up some upside gains in the event of a massive rally, but you’re also protecting against losses that can quickly mount and hurt a portfolio.
The Innovator Buffer ETFs are all still relatively new, and traction has been slow but growing, especially as investors fret over a government shutdown, slower U.S. growth and a possible recession ahead. UOCT costs 0.79% in expense ratio.
The Pacer Trendpilot U.S. Large Cap ETF (PTLC) is Pacer’s biggest ETF today, with $1.63 billion in assets. It’s only one in Pacer’s family of Trendpilot ETFs that offers equity exposure and downside protection in a single wrapper.
As the name suggests, this ETF—and its counterparts in this lineup—are trend-following portfolios. PTLC toggles between U.S. large-cap equity exposure and three-month U.S. Treasury bills for safety based on momentum indicators such as 200-day moving average.
When things aren’t going that well, the allocation to T-bills goes up. When the market is on fire, equities dominate the portfolio. By design, this strategy can be 100% equity, 100% cash (in the form of T-bills) or somewhere closer to 50/50.
It’s the kind of strategy that allows you to access equities, but limit downside by moving your allocation automatically to cash. In recent months, the performance of PTLC versus the S&P 500 (as measured by the SPDR S&P 500 ETF Trust (SPY)) has diverged notably, as the one-year chart below shows:
Chart courtesy of StockCharts.com