Many Flavors Of Defensive Equity ETFs

January 16, 2019

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 Buffer ETFs

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.

 

Source: Innovator

 

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.

Pacer Trendpilot ETFs

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

Real Asset ETFs

The FlexShares Morningstar Global Upstream Natural Resources Index Fund (GUNR) is Northern Trust’s FlexShares biggest ETF, with $5.17 billion in total assets. It’s an equity fund focused on companies that produce, manage or operate all sorts of global natural-resources-related businesses.

The strategy has some caps to limit portfolio concentration on any specific segment, and offers access to companies involved with everything from energy to oil to agriculture to metals to timber and water. It costs 0.46% in expense ratio.

 

Source: ETF.com

 

Natural resources-linked companies aren’t immune to market downturns. GUNR is an equity portfolio 100% allocated to equities at all times. But some argue that global demand for so-called real assets (natural resources and commodities) keeps on growing in the aggregate, and these companies could deliver growth (and resiliency) at a time when other sectors of the economy may struggle.

GUNR is the largest ETF in this segment, but there are others, such as the IQ Global Resources ETF (GRES), the iShares North American Natural Resources ETF (IGE) and the SPDR S&P Global Natural Resources ETF (GNR), to name a few.

 

Year-to-Date Performance vs. SPY

Chart courtesy of StockCharts.com

 

Inverse Equity ETFs

Finally, if you are a market bear of full conviction, you can always short U.S. equities with inverse ETFs, betting on the downside. An inverse ETF shouldn’t be called portfolio “protection,” but it’s certainly a tool at your disposal if you believe the stock market is going down.

The biggest strategy in this segment is the ProShares Short S&P500 (SH), with $2.3 billion in total assets. SH is a one-day bet against the S&P 500—the fund delivers the inverse exposure to the index for one trading day. It costs 0.89%.

For additional leverage, there are also funds like the ProShares UltraShort S&P500 (SDS), which offer 2x the inverse results of the S&P 500 on a given day, or the ProShares UltraPro Short S&P500 (SPXU), serving up 3x inverse exposure to the index for one day.

These are just some of the many U.S. equity inverse ETFs you can choose from—all designed as short-term trading tools. Here’s their performance relative to the S&P 500 in 2019:

 

Chart courtesy of StockCharts.com

 

This list of equity-based defensive plays isn’t exhaustive or comprehensive. It’s merely a conversation starter about portfolio protection, and the many ETF tools available to that end.

Do you have a favorite “defense” ETF? If so, I’d love to hear about it.

Contact Cinthia Murphy at [email protected]

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