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How to Hedge Market Volatility With ETFs

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After an astounding rally in the past five months, the stock market volatility returned with a sharp selloff in tech stocks due to overvaluation concerns. The lack of progress in an additional fiscal stimulus bill in Washington, delay in the late-stage trial of the leading COVID-19 vaccine candidates from AstraZeneca Plc (AZN - Free Report) , budget negotiations, and election uncertainty added to the chaos.

Further, geopolitics continued to be an overhang on the stocks. In the latest development, President Donald Trump is seeking to curb the U.S. relationship with China, threatening to punish any American company that creates jobs overseas and forbid those that do business in China from winning federal contracts. The Trump administration is also considering another ban on China’s cotton.

The bouts of volatility will likely continue given the seasonal phenomenon. This is especially true as September is historically a weak month for the stock market (read: ETF Strategies to Tackle Volatile September).
However, the euphoria surrounding COVID-19 vaccine and continued support from the Fed should offer some upside to the stocks. In a recent news conference, President Donald Trump said he believed a COVID-19 vaccine could be approved as soon as in October. Further, encouraging data indicate that the American economy is gradually returning to the pre-pandemic level and that COVID-19 cases are moderating.

In such a scenario, investors should apply some hedging techniques to their equity portfolio. While there are a number of ways to do this, we have highlighted five volatility-hedged ETFs that could prove beneficial amid market uncertainty. Investors should note that these funds have the potential to stand out and outperform the simple vanilla funds in case of rising volatility.

How to Play

Innovator S&P 500 Power Buffer ETF (POCT - Free Report)

This is an actively traded ETF that seeks to track the return of the S&P 500 Price Return Index, up to a predetermined cap, while buffering investors against the first 15% of losses over the outcome period. It has amassed $422.1 million in its asset base and trades in average daily volume of 59,000 shares. POCT charges 79 bps from investors in annual fees and expenses.

DeltaShares S&P 500 Managed Risk ETF

This ETF seeks to track the S&P 500 Managed Risk 2.0 Index, which is designed to simulate a downside-protected portfolio by utilizing a framework that includes targeted volatility and a synthetic option overlay to hedge the downside risk of the portfolio. DMRL has accumulated nearly $375 million in its asset base and trades in light volume of 6,000 shares. It charges 35 bps in fees per year (read: Here's Why it Makes Sense to Invest in Low-Volatility ETFs Now).    

Invesco S&P 500 Downside Hedged ETF (PHDG - Free Report)

This actively managed fund seeks to deliver positive returns in rising or falling markets that are not directly correlated to broad equity or fixed-income market returns. It tries to follow the S&P 500 Dynamic VEQTOR Index, which provides broad equity market exposure with an implied volatility hedge by dynamically allocating between different asset classes: equity, volatility and cash. The S&P 500 Total Return Index represents the equity component while the S&P 500 VIX Short-Term Futures Index represents the volatility component of the index. The non-equity (volatility + cash) portion makes up for one-fourth of the portfolio while the rest goes to equity. The fund has accumulated $141.8 million in its asset base and charges 39 bps in fees per year from investors. Volume is light, exchanging 83,000 shares a day on average.

Nationwide Risk-Based U.S. Equity ETF

This ETF follows the Rothschild & Co Risk-Based US Index and employs a risk-based strategy that seeks to provide upside potential, while protecting against losses stemming from volatility. It holds well-diversified 251 stocks in its basket with AUM of $105.7 million. It charges 30 bps in annual fees and trades in thin volume of 5,000 shares a day on average.

Aptus Drawdown Managed Equity ETF (ADME - Free Report)

This ETF seeks capital appreciation with a focus on managing drawdown risk through hedges. The strategy typically selects 40-50 large U.S. companies based on a Yield plus Growth framework, filtering candidates on dividend yield, growth outlook, valuation and price momentum. It has an added objective of capital protection through the use of equity and index options to reduce drawdown when U.S. equity markets are falling. The fund charges 79 bps in annual fees and has accumulated $158.9 million in its asset base (read: 5 ETFs to Invest Amid Market Rout).

Bottom Line

Investors can definitely shield their portfolio against volatility with the help of the above-mentioned products. These provide dynamic exposure according to the level of market volatility and are least affected by any market turmoil. So, they could prove to be great choices when it comes to offering protection against market downturn.

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