Louis Navellier's extraordinary “stock-picking GPS” strategy found Apple at $1.49.

Now it’s flashing STRONG BUY again...

Wed, September 30 at 4:00PM ET
 
 
 
 

3 Ways You Can Use ETFs to Cover Your Butt

Worried about additional volatility and a drop-off in the coming months? Look to these strategies for help.

Investors are no doubt concerned about September’s rockiness turning into a more serious selloff. This uncertainty is even more warranted when you consider that September is historically the weakest month of the year, and we’re still far from being out of the weeds and in October.

bear-market-lazy-630-ISP
Source: ©iStock.com/blewisphotography

According to recent data published by Yardeni Research, the month of September has had an average annual return of negative 1% since 1928. That’s certainly not an inspiring statistic even in light of the resilience in stocks over the last several years.

While I don’t recommend making changes strictly in adherence to monthly average returns, a portfolio that is fully invested might want to make some subtle shifts if additional volatility picks up. That could include adding a traditional inverse position to hedge existing longs, moving a portion of the portfolio to cash, or swapping out high beta sectors for more defensive positions.

Hedging a portfolio of existing longs can be a useful strategy to protect gains of highly appreciated positions. However, it can often be difficult to execute if you are not highly disciplined with your entry point and risk parameters. Most investors opt to accomplish this feat by using options or shorting individual securities.

However, you simply might not have those options in an IRA or similar retirement account.

So, what could you do?

#1: Inverse ETFs

One potential alternative is to use an inverse ETF such as the ProShares Short Russell 2000 ETF (RWM). This fund seeks to provide investment results that correspond to the inverse price movement of the Russell 2000 Index on a daily basis. The underperformance of the iShares Russell 2000 ETF (IWM) has been well documented this year and continues to be a thorn in the side of small cap investors. If the markets do roll over, this small-cap index might find itself retesting its 2014 lows.

I typically only encourage investors to add inverse ETFs with short time horizons and a defined sell discipline. That way if the market does continue to move higher, you are able to exit the position with only a small loss and it doesn’t weigh significantly on long-term performance.

#2: Defensive ETFs

Another strategy to consider is shifting to a defensive holding such as the PowerShares S&P 500 Low Volatility Portfolio (SPLV) or PowerShares S&P 500 Downside Hedged Portfolio (PHDG). SPLV invests in the 100 lowest-volatility stocks in the S&P 500 Index, while PHDG is an active ETF that rotates between equities, volatility and cash. Both funds are designed to allow you the flexibility to still capture upside momentum with lower overall drawdown than a fully loaded stock index.

The key to these ETFs is being aware that they will likely underperform in a sharply rising market. The very same qualities that make them attractive as defensive positions will be their Achilles heel when high-beta sectors dominate.

#3: Cash or Short-Term Bonds

Lastly, don’t count out cash or short-term bond funds such as the Vanguard Short-Term Bond ETF (BSV)as an option to preserve capital. Money market funds can be a temporary hideout, allowing you to safely scan the investment universe with a clear head and deploy capital at opportunistic entry points.

The biggest mistake that investors make with cash is holding too much of it for too long and watching the world pass them by. You have to be disciplined enough to step back into stock, bonds, or commodities at a predetermined level to avoid damaging your returns.

Bottom Line

Hedging your exposure can take multiple forms that will vary for each investor according to your risk tolerance, comfort level, and existing exposure. I always recommend avoiding large bets that can considerably skew your asset allocation and divert focus away from core positions that will be the primary drivers of long-term returns.

However, these tactical tools can make an impact in lowering portfolio volatility through strategic positioning.

David Fabian is Managing Partner and Chief Operations Officer of FMD Capital Management. As of this writing, he did not hold a position in any of the aforementioned securities. Check out David and Michael’s latest special report, The Strategic Approach to Income Investing.


Article printed from InvestorPlace Media, https://investorplace.com/2014/09/etfs-bear-market/.

©2020 InvestorPlace Media, LLC