An ETF Strategy for Tailored Market Hedging

Two ETFs track volatility as a signal to add market protections.

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Jeff_Benjamin
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Wealth Management Editor
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Reviewed by: etf.com Staff
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Edited by: James Rubin

When it comes to hedging market risk, ETF investors have been falling in love with buffered and collared strategies that limit losses in exchange for upside performance caps.

Some analysts call these strategies “Boomer Candy” because of their popularity among investors in or near retirement who want to stay invested but with a smoother ride.

Unfortunately, that smoother ride means hedging the markets all the time, and that can result in a long-term drag on performance, especially during periods of extended bull market runs.

That’s essentially the issue being addressed by a couple of brothers from Chicago who have been running a strategy since 2016 that buys and sells volatility futures contracts to tactically pair with an underlying index to navigate market volatility.

In 2022, Mike and Matt Thompson, portfolio managers and co-founders of Thompson Capital Management, partnered with Little Harbor Advisors in Marblehead, Mass. to wrap their strategy into a couple of ETFs.

The LHA Market State Tactical Beta ETF (MSTB) applies the risk overlay strategy to the S&P 500 Index, and the LHA Market State Tactical Q ETF (MSTQ) applies the same overlay strategy to the Nasdaq Composite Index.

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Hedging Market Risks

As Matt Thompson explained, the actively managed strategy monitors the market volatility index by comparing the price of the VIX relative to the markets to determine when to buy a VIX futures contract to hedge the underlying index.

“The philosophy is the VIX is the premier hedging marketplace that is globally operating 24 hours a day,” he said. “We watch the pricing there and if we see the VIX market show increasing demand for hedges, that’s our cue to add our own hedges.”

A key element to the strategy is the use of futures to hedge the broader market only when the numbers point toward increased volatility. And for that reason, Thompson said the ETFs are only hedged about 15% of the time, which means the ETFs are mostly long the underlying index.

“We’re trying to be cost conscious and a hedge all the time cost money,” Thompson said.

As a separately managed account that dates to November 2016, the strategy used in MSTB has generated an annualized return over the past eight years of 16.3%, which compares to 15.4% for the underlying S&P 500 Index over the same period.

For a stark example of how the strategy has worked, consider the extreme volatility of the early days of Covid in March 2020 when the S&P lost 12% and the MSTB strategy gained 19.5%.

For the full year of 2020, the strategy gained 56%, while the S&P gained 18.4%.

But, while the strategy has shined during periods of extreme volatility and market declines, Thompson acknowledges a potential shortcoming when volatility isn’t there to signal a time to buy hedging futures.

“In 2022 we didn’t do so well,” he said. “That was a rare circumstance of a substantial decline without much volatility.”

That year MSTB lost 22.6% while the S&P lost 18.1%.

“In that scenario what works better is a traditional strategy of keeping the hedge on the whole time,” Thompson said.

Jeff Benjamin is the wealth management editor at etf.com, responsible for coverage related to the financial planning industry. This includes writing, hosting podcasts, webinars, video interviews and presenting at in-person events.


Jeff is a veteran journalist with more than 30 years’ experience covering the financial markets. He has won more than two dozen national and regional awards for his reporting. He most recently worked as a senior columnist at InvestmentNews where he wrote about investment products and strategies, as well as the broader financial planning industry. Prior to that, Jeff worked as an analyst at Cerulli Associates where he researched and wrote reports on the alternative investments industry. Jeff also worked as a money management reporter at Dow Jones Newswires, where he covered the mutual fund industry.


Based in North Carolina, Jeff is a former Marine and has a bachelor’s degree in journalism from Central Michigan University.

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