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How to Hedge Volatility With ETFs

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As inflation concerns started to build up, U.S. stocks have started faltering this month. After notching the biggest one-day drop in its history on Monday, the Dow Jones witnessed violent swings in Tuesday’s trading session to post the biggest rally since January 2016. (read: Inverse Equity ETFs to Bet on Historic Selloff).

Notably, the blue-chip index traded in a range of nearly 1,200 points, changing direction 29 times over the course of the session before surging in the final hour to close up 2.3%. This marks the second-biggest intraday trading range in the Dow’s history. This indicates heightened volatility in the stock market.

The CBOE Volatility Index (VIX), also known as the fear gauge, hits 50 for first time since 2015 on Tuesday before retreating to 30 at the close, which was still above its historic average. The index soared 115.6% on Monday — its biggest one-day jump on record. The fear gauge measures investors’ perception of the market’s risks and tends to rise when stock falls or investor panic starts to set in.

The initial sell-off in stocks was triggered by a sharp rise in U.S. bond yields late last week following the January jobs data, which shows wages increased at a faster rate since 2009. This has raised concerns over higher inflation that might force the Fed to adopt speedy rate hikes. Higher-than-expected rise in interest rates would lead to a rise in borrowing cost, thereby dulling the appeal for equities. Further, pick-up in economic growth across many developed and developing countries led to the prospect of an end to the cheap monetary policy era outside United States. All these are weighing heavily on the bull market, which is drawing closer to its ninth anniversary (read: 6 Ways to Build a Rate-Proof Portfolio With ETFs).

However, long-term equity fundamentals remain intact thanks to strong corporate earnings, higher consumer spending, rising consumer confidence as well as a new tax law enacted by President Donald Trump.

In order to exploit the encouraging trend amid volatility, investors should apply some hedge 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 turbulence. Investors should note that these funds have the potential to stand out and might outperform the simple vanilla funds in case of rising volatility.

How to Play

DeltaShares S&P 500 Managed Risk ETF (DMRL - Free Report)


This ETF seeks to track the S&P 500 Managed Risk 2.0 Index, which is designed to simulate a downside-protected portfolio, which utilizes a framework that includes targeted volatility and a synthetic option overlay to hedge the downside risk of the portfolio. It holds 508 securities in its basket with each accounting for less than 3.6% of assets. DMRL has accumulated nearly $399.7 million in its asset base and trades in a light volume of 6,000 shares. It charges 35 bps in fees per year (read: 7 Successful New ETFs of 2017).   

Nationwide Risk-Based U.S. Equity ETF (RBUS - Free Report)

This ETF follows the R 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 none of the securities accounting for more than 1.52% share. RBUS has newly debuted in the space and accumulated $114.4 million within five months. It charges 30 bps in annual fees and trades in a thin volume of 2,000 shares a day on average (read: Wall Street Sees Worst Sell-Off in Years: 5 ETF Buying Zones).

Janus Velocity Volatility Hedged Large Cap ETF

This ETF tracks the VelocityShares Volatility Hedged Large Cap Index and looks to hedge "volatility risk" in the S&P 500. It offers investors exposure to not only the S&P 500 but also both long and inverse exposure in short-term VIX futures. The product provides target equity exposure of 85% to the S&P 500 using large-cap ETFs, while the remaining 15% goes to the volatility strategy through one or more swaps. The fund has $63.9 million in AUM and charges 70 bps in annual fees. It trades in small volumes of 6,000 shares a day on average.

Barclays ETN+ S&P VEQTOR ETN (VQT - Free Report)

This is an ETN option tracking the S&P 500 Dynamic VEQTOR Index. VQT uses volatility futures contracts directly to hedge volatility. It increases allocation to the equity component as measured by the S&P 500 Total Return Index in times of low volatility. On the other hand, it increases volatility exposure as measured by the S&P 500 VIX Futures Total Return index and allocates entirely into cash if the index slumps 2% or more in the preceding five days. In this manner, the note manages to keep a check on volatility. The product has amassed $25.7 million in AUM and charges higher 95 bps in annual fees. The ETN sees paltry average daily volume of 4,000 shares.
   
PowerShares S&P 500 Downside Hedged Portfolio (PHDG - Free Report)

This actively managed fund seeks to deliver positive returns in rising or falling markets that are uncorrelated 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 $24.2 million in its asset base and charges 39 bps in fees per year from investors. Volume is light exchanging 3,000 shares a day on average.

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. These are least affected by any market turmoil and could prove to be great choices when it comes to offering protection against market downturn.

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