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Hedge Market Volatility With These ETFs

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Market volatility has returned this year on fading bets over interest rate cuts, with the CBOE Volatility Index (VIX), also known as fear gauge, rising to a two-month high. This suggests that market worries have started to set in. This fear gauge tends to outperform when markets are declining or when fear levels pertaining to the future are high (read: Cash-Like ETFs Spike Amid Market Turmoil).

In such a scenario, investors should apply some hedging techniques to their equity portfolio to reduce the overall volatility or protect against significant market downturns. While there are a number of ways to do this, volatility-hedged ETFs seem compelling choices. Some of these are Global X Russell 2000 Covered Call ETF (RYLD - Free Report) , iMGP DBi Managed Futures Strategy ETF (DBMF - Free Report) , Aptus Drawdown Managed Equity ETF (ADME - Free Report) , Invesco S&P 500 Downside Hedged ETF (PHDG - Free Report) and First Trust Managed Futures Strategy Fund (FMF - Free Report) .

Investors should note that these funds have the potential to stand out and outperform simple vanilla funds in case of rising volatility.

What Are Volatility-Hedged ETFs?

Volatility-hedged ETFs are investment products designed to mitigate the impact of market volatility on a portfolio. These ETFs typically aim to provide investors with exposure to a particular asset class or market while reducing the impact of price fluctuations resulting from market volatility.

The basic premise behind volatility-hedged ETFs is to combine a long position in an underlying asset or market with a short position in volatility futures or options contracts. By shorting volatility, these ETFs attempt to offset or "hedge" the potential losses that may occur during periods of heightened market volatility (read: 5 ETF Tactics for Your Portfolio in 2024).

These ETFs are often structured to provide targeted exposure to specific markets, such as equities or fixed income, while attempting to reduce the impact of volatility on returns. They may employ various strategies and techniques, including options, futures contracts and other derivatives, to achieve their objective.

However, these ETFs may not always provide complete protection during extreme market events and may have additional costs associated with their hedging strategies.

Rate Cut Bets Ease

The bouts of stronger-than-expected economic data have pushed back the expectations for early rate cuts. Retail sales came in hotter than expected, signaling economic strength, while the latest inflation and jobs data also dampened market expectations about an interest rate hike as soon as March.

The latest Fed minutes showed that the central bank wouldn’t cut rates as aggressively as expected for this year. This suggests an uncertain path toward interest rate cuts and reflects a growing sense that inflation is under control. One of the Fed officials Governor Christopher Waller said the Fed should not rush to lower rates as inflation is approaching the U.S. central bank's 2% goal.

As of Jan 17, markets priced in a 57% chance of the Fed cutting rates in March, per the CME FedWatch Tool, down from a 67% chance last week and a 71% chance seen a month ago.

ETFs in Focus

Global X Russell 2000 Covered Call ETF (RYLD - Free Report)

Global X Russell 2000 Covered Call ETF seeks to generate income through covered call writing, which historically produces higher yields in periods of volatility. It follows a “covered call” or “buy-write” strategy, in which the fund buys the stocks in the Russell 2000 Index (at times by exposure to the Vanguard Russell 2000 ETF) and “writes” or “sells” corresponding call options on the Russell 2000 Index (read: Covered Call ETFs: A High-Yield Income Strategy for Investors).

Global X Russell 2000 Covered Call ETF has AUM of $1.4 billion and trades in an average daily volume of 831,000 shares. The ETF charges 60 bps in fees per year.

iMGP DBi Managed Futures Strategy ETF (DBMF - Free Report)

iMGP DBi Managed Futures Strategy ETF seeks long-term capital appreciation. It will employ long and short positions in derivatives, primarily futures contracts and forward contracts, across the broad asset classes of equities, fixed income, currencies and commodities.

iMGP DBi Managed Futures Strategy ETF has AUM of $685.5 million and charges 85 bps in annual fees. It trades in a moderate volume of 465,000 shares a day on average.

Aptus Drawdown Managed Equity ETF (ADME - Free Report)

Aptus Drawdown Managed Equity ETF seeks capital appreciation with a focus on managing drawdown risk through hedges. The strategy typically selects 50-75 large U.S. companies based on a yield plus growth framework, tilting holdings to favor companies with solid fundamentals and reasonable valuations while avoiding those with negative 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.

Aptus Drawdown Managed Equity ETF charges 79 bps in annual fees and has accumulated $157.1 million in its asset base. It trades in an average daily volume of 14,000 shares.

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

Invesco S&P 500 Downside Hedged ETF is an actively managed fund that seeks to deliver positive returns in rising or falling markets that are not directly correlated to broad equity or fixed-income market returns. Invesco S&P 500 Downside Hedged ETF 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 index allows investors to receive exposure to the equity and volatility of the S&P 500 Index in a dynamic framework.

Invesco S&P 500 Downside Hedged ETF has accumulated $128.3 million in its asset base and charges 39 bps in fees per year from its investors. Volume is good, exchanging 28,000 shares a day on average.

First Trust Managed Futures Strategy Fund (FMF - Free Report)

WisdomTree Managed Futures Strategy Fund seeks to achieve positive returns that are not directly correlated to broad market equity or fixed income returns by investing in a portfolio of exchange-listed futures.

First Trust Managed Futures Strategy Fund has accumulated $138.4 million and charges 95 bps in annual fees. It trades in a moderate volume of 36,000 shares a day on average.

Bottom Line

Investors can shield their portfolios against volatility with the help of the abovementioned 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 downturns.

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