ETFs and the Downgrade Lessons of 2011

The clock was ticking for the U.S. to avoid defaulting on its debt. Economists warned of the cascade of stress points for consumers and financial markets. Politicians dug in their heels.

History again appears to be rhyming, as events of this spring mirror those of the summer of 2011.

The stock market nearly collapsed that year, due to similar worries that are in place again now. However, the fact that the debt ceiling was ultimately raised, and the stock market rallied during the fourth quarter to post a full-year 2011 net gain of 2% is likely why 2011 is not mentioned in the same breath as 2002, 2008 and 2022. But it sure was a close call.

Now investors can take some solace from a wide range of exchange-traded fund styles they can use to position themselves, should that threat soon become a reality. 

After starting 2011 with an 8% gain, just as the S&P 500 has in 2023, the market topped out in mid-July as the debt ceiling issue shifted from potential risk to real-time crisis, as it is doing now. The next two weeks saw that index crater by nearly 17%, culminating in a Standard and Poor’s downgrade of the U.S. debt rating from its coveted AAA rating to AA+ in August. 

There were only about 1,100 ETFs to choose from 12 years ago, and that figure has tripled to more than 3,000. That includes a dramatic increase in the number of ways investors can protect themselves from the type of sharp, temporary stock market declines such as in 2011, as well as ways to protect and profit if things don’t end as calmly as they did back then. 

For example, investors can consider ETFs that keep them invested in the equity market, but have a “trap door” of sorts in case calamity strikes.

The Invesco S&P 500 Downside Hedged ETF (PHDG) is 90% invested in the S&P 500, but uses the other 10% of its portfolio to buy VIX short-term futures. Typically, when markets tank, the VIX volatility index flies. That was the case during that tumultuous two-week period in 2011. 

In another ironic twist, the VIX stood at around 17 during the debt ceiling scare of 12 years ago, just as it does now. In 2011, it moved from that 17 level to a high of 48 just two weeks later. PHDG launched in late 2012, but has weathered market crashes well, particularly in 2020’s flash decline as the pandemic began. 

The Simplify Hedged Equity ETF (HEQT) has a similar aim, but a different methodology. It invests nearly all of its assets in an S&P 500 ETF, but surrounds that stock market exposure with a small position in a set of “put spread collars,” a combination of three different option contracts that aim to stunt downside risk while allowing for a portion of the S&P 500’s upside. HEQT and PHDG both limited losses to about 8% during 2022’s difficult year for equity investors. 

There’s also the Aptus Drawdown-Managed Equity ETF (ADME), an actively managed ETF that combines a stock portfolio with a set of option “collars” (selling a call option and buying a put option) on both the S&P 500 and on some of the ETF’s stock holdings.

This year and 2011 are increasingly similar. However, one way in which things have changed is that the ETF industry has evolved to include a diverse set of funds that, unlike 12 years ago, can be used by investors to stay invested in the stock market but have some protection against sudden price declines.