The Market Can’t Hold a Rally. Time to Hedge With ETFs

A wide range of funds is available to prevent losses.

Reviewed by: Lisa Barr
Edited by: Ron Day

The stock market can't hold a rally, even for a morning. 

That was the case Aug. 8 after the CPI report initially thrilled, then chilled, equity investors. Market technical indicators are hinting at a potential correction at best, and a classic autumn mess at worst, setting up a class of ETFs to be “wealth savers.”  

That is, for those investors who know how they work. 

No matter how much investors believe in the concept of “diversification,” one distinguishing feature of modern markets is that when stocks go from just weakening to falling hard and fast, it tends to be a one-way trade, so to speak. Few, if any, places are available to hide.  

This has a lot to do with the massive popularity of indexing and ETF investing, since market sell-offs occur in “baskets” as opposed to one stock at a time, like in the old days. 

As a relatively calm summer approaches the seasonally risky months of September and October, the thought of hedging an equity portfolio naturally rises as a priority. At least, it should, for advisors aiming to protect retired or retiring clients. 

ETF investors, and financial advisors who deploy them in portfolios, should have an advantage over those who are less familiar with ETFs and the trend over the past decade of indexation of the stock market. This is a good time to deploy knowledge of how to hedge equity portfolios using ETFs.  

Plethora of Hedged ETFs 

Advisors and their clients have never had a more robust array of hedged ETFs to consider. In addition to owning ETFs that buy stocks and hold them, they can use these vehicles to protect some of that capital at risk, or to take a more “one foot in the door” approach to equity investing during times of heightened uncertainty … like right now. 

Below are a few categories of hedged ETFs, and one example of each type: 

The Global X S&P 500 Covered Call ETF (XYLD), a $3 billion fund, aims to track an index that conducts a “buy-write” program on the S&P 500 index. That is, it owns the stocks in the index, and each month writes covered call options to bring in cash flow against that portfolio. That trades off that cash flow for most of the S&P 500’s upside but provides some protection when the market is dropping. This may be the most familiar type of hedge to many investors, as private investors have been writing covered calls on stocks for decades.  

As the name implies, the Invesco S&P 500 Downside Hedged ETF (PHDG) hedges stock market downside. However, that doesn’t mean it doesn’t get its fair share of upside. This relatively undiscovered, $166 million ETF owns the S&P 500 with 90% of its portfolio and applies a “disaster hedge” using the other 10%, in the form of buying call options on the VIX volatility Index. During calm markets, it can ebb and flow with the S&P 500, albeit with a modest return drag from that 10% hedge. But in times of market chaos, such as in early 2020 when the pandemic broke, this ETF lived up to its potential. 

The Aptus Collared Investment Opportunity ETF (ACIO) is an actively managed fund that starts with the managers’ owning 50 stocks. From there, they sell covered calls on those stocks. But since that only adds cash flow and cuts some of the downside, ACIO applies an extra protective layer by buying put options on a major stock market index. ACIO, a $563 million ETF, is just over four years old, and has delivered a solid 8.9% return so far in 2023. 

Time for Hedged ETFs? 

With the stock market showing at least early indications of tiring after a monster run-up, investment advisors have an “ace” in their pockets in the form of a wide variety of hedged ETFs.  

Next step: Research them, find the ones that best fit the clientele of the practice, and explain to clients how you went the extra mile to protect their assets. 

Rob Isbitts was an investment advisor for 27 years before selling his practice to focus on ETF research and education. He is based in Weston, Florida. Contact him at  [email protected] and follow him on LinkedIn.