3 ETF Strategies to Ride Out Summer Volatility

by Susan J. Aluise | May 16, 2012 12:25 pm

“Sell in May and go away; come back on St. Ledger’s Day”

That old Wall Street proverb is one of those classic market truths everybody quotes like “Money follows earnings,” or “Buy when there’s blood on the streets.” Still, despite the current “sell in May”[1] buzz, investors may be better served buying ETFs that can compensate for — or even profit from — the season’s increased volatility.

Like InvestorPlace’s Daniel Putnam I’m dubious about the sell in May strategy[2] for a couple of reasons. First, while examining market history and charting trends can provide insights, don’t forget another investment adage: “Past performance is no guarantee of future results.” These historic trends are true until they’re not. Second, any adage linking investment timing to a 236-year-old British horse race[3] runs the risk of lagging well behind today’s markets.

When it comes to investing, I’ll stick with situational awareness. This is a high-stakes U.S. presidential election year, Greece is once again circling the drain and the euro’s future is in doubt[4]. The “Whalegate” fallout over [5]JP Morgan Chase[6]’s (NYSE:JPM[7]) bad bet is far from over and just might topple President Obama’s banking industry buddy Jamie Dimon.

For these and myriad other reasons, the one thing we can count on this summer is volatility. Here are three ETF investing approaches, from highest to lowest risk, to consider as potential volatility plays. Keep in mind that these are short-term trading ideas and some can pose substantial downsides if considered as part of a long-term strategy.

Inverse or Leveraged Europe Funds

Of these three strategies, ETFs that bet against Europe have the highest potential risk, but also the best potential return. It’s important to know that short or leveraged ETFs have come under fire[8] recently because they’re not suitable buy-and-hold investments. Their purpose is to capitalize on sharp, short-term moves tied to market events.

With all the challenges Europe is facing, hedging with inverse, leveraged ETFs can make sense if you view them as very short-term and you risk no more than 3% to 5% of your assets. In that case, consider ProShares UltraShort MSCI Europe (NYSE:EPV[9]) or Market Vectors Double Short Euro ETN (NYSE:DRR[10]).

EPV aims to achieve performance double the inverse daily performance of the MSCI Europe Index. Trading at around $44, EPV has a market cap of $174.7 million,  a three-month return of 10% and a one-month return of nearly 6%. This ETF is a leveraged bet that the political and fiscal fury blowing through Europe will spark a sharp, short dip in eurozone markets.

DRR is an exchange traded note (ETN) that’s a short-term bet on fears that the euro will collapse. It’s double-leveraged to enhance daily exposure. Trading around $47, DRR has a market cap of $94 million, and three-month and one-month returns of around 4%.

The Emerging Markets Bounce

Investing in emerging markets is an average risk strategy and is not a short-only play. Emerging markets haven’t really bought into the seasonal performance argument, so these ETFs should still perform for your portfolio during the summer months and beyond, depending on how the underlying economies do. I like two emerging markets plays right now — one diversified and one single-country.

PowerShares Emerging Markets Sovereign Debt Portfolio (NYSE:PCY[11]) is a good diversified ETF. It aims to match the performance of DB Emerging Market USD Liquid Balanced Index and includes debt from Brazil, Peru, Korea, Vietnam and Pakistan. With a market cap of nearly $1.8 billion, PCY is trading around $28. It has a year-to-date performance of 5% and a one-month return of nearly 1%.

For single-country ETFs, I like iShares MSCI Philippines Investable Market Index Fund (NYSE:EPHE[12]) which seeks to match the returns of that Philippine stock index. Holdings include shopping mall developer SM Investments, real estate company Ayala Land and Philippine Long Distance Telephone. With a $134 million market cap, EPHE is trading around $27. It has a year-to-date return of nearly 20% and a flat one-month return.

Low-Beta Holdings

If you’re looking for an alternative to selling in May, but want to stay as conservative as possible, try ETFs with low-beta holdings. Beta is a measure of volatility as it compares to the overall market. The market has a beta of 1, so if a stock’s beta is higher than 1, it’s considered high volatility; lower than 1 is considered low volatility. Low-beta ETFs are the safest funds because they’re defensive in nature.

Since low-volatility ETFs focus on stable stocks that are less prone to the market fits and starts, the biggest risk is leaving money on the table when the volatility ebbs. I like these two dull, but delightful ETFs: Vanguard Utilities ETF (NYSE:VPU[13]) and MSCI USA Minimum Volatility Index (NYSE:USMV[14]).

VPU’s holdings are focused primarily on U.S. energy utilities like Southern (NYSE:SO[15]), Exelon (NYSE:EXE[16]), Dominion Resources (NYSE:D[17]) and Duke Energy (NYSE:DUK[18]). With a market cap of over $1 billion, VPU is trading around $76. Its year-to-date performance is less than 1%, but its one-month return is 4.3%.

If you’re looking for broader sector diversification, look to USMV, which includes utilities like AT&T (NYSE:T[19]), consumer staples like Coca-Cola (NYSE:KO[20]) , health care stocks like Eli Lilly (NYSE:LLY[21]) and even a few high-beta tech companies like Microsoft (NASDAQ:MSFT[22]). USMV has a market cap of $65 million and is trading around $28. Its year-to-date performance is 5.7%, and its one-month return is flat.

As of this writing, Susan J. Aluise does not hold a position in any securities mentioned here.

  1. “sell in May”: https://investorplace.com/2012/04/sell-in-may-and-go-away-yea-or-nay/
  2. dubious about the sell in May strategy: https://investorplace.com/2012/05/sell-in-may-the-real-story/
  3. 236-year-old British horse race: http://stleger.racingpost.com/guide/
  4. euro’s future is in doubt: https://investorplace.com/2012/05/the-euro-whats-done-is-done/
  5. fallout over : https://investorplace.com/2012/05/jump-on-the-exodus-in-jpmorgan/
  6. JP Morgan Chase: https://investorplace.com/2012/05/jump-on-the-exodus-in-jpmorgan/
  7. JPM: http://studio-5.financialcontent.com/investplace/quote?Symbol=JPM
  8. short or leveraged ETFs have come under fire: https://investorplace.com/2012/04/3-things-to-know-about-inverse-etfs/
  9. EPV: http://studio-5.financialcontent.com/investplace/quote?Symbol=EPV
  10. DRR: http://studio-5.financialcontent.com/investplace/quote?Symbol=DRR
  11. PCY: http://studio-5.financialcontent.com/investplace/quote?Symbol=PCY
  12. EPHE: http://studio-5.financialcontent.com/investplace/quote?Symbol=EPHE
  13. VPU: http://studio-5.financialcontent.com/investplace/quote?Symbol=VPU
  14. USMV: http://studio-5.financialcontent.com/investplace/quote?Symbol=%20%20USMV
  15. SO: http://studio-5.financialcontent.com/investplace/quote?Symbol=SO
  16. EXE: http://studio-5.financialcontent.com/investplace/quote?Symbol=EXE
  17. D: http://studio-5.financialcontent.com/investplace/quote?Symbol=D
  18. DUK: http://studio-5.financialcontent.com/investplace/quote?Symbol=DUK
  19. T: http://studio-5.financialcontent.com/investplace/quote?Symbol=T
  20. KO: http://studio-5.financialcontent.com/investplace/quote?Symbol=KO
  21. LLY: http://studio-5.financialcontent.com/investplace/quote?Symbol=LLY
  22. MSFT: http://studio-5.financialcontent.com/investplace/quote?Symbol=MSFT

Source URL: https://investorplace.com/2012/05/3-etf-strategies-to-ride-out-summer-volatility/
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