ETFs to Limit the Damage of a Stock Correction

August 19th at 12:43pm by John Spence

Low-volatility ETFs have been a popular tool after the financial crisis with investors who want downside protection while maintaining a core position in equities.

For example, iShares MSCI USA Minimum Volatility ETF (NYSEArca: USMV) and PowerShares S&P 500 Low Volatility Portfolio (NYSEArca: SPLV) are among the biggest offerings for this strategy. They focus on stocks that have exhibited smaller fluctuations in price. [ETFs to Help Hedge Market Volatility]

“However, the drawback with these ETFs is that in a widespread selloff, they still are susceptible to substantial declines,” writes David Fabian at Fabian Capital Management in a commentary for InvestorPlace.com.

He points to PowerShares S&P 500 Downside Hedged Portfolio (NYSEArca: PHDG) as a potential alternative. The ETF seeks to achieve positive total returns in rising or falling markets that are not directly correlated to broad equity or fixed-income market returns.

The ETF provides investors with broad equity market exposure with an implied volatility hedge by dynamically allocating between equity, volatility and cash.

PHDG has a 97.5% allocation in stocks and 2.5% in the CBOE Volatility Index, or VIX. [PowerShares Readies ‘Downside Hedged’ ETF]

“Clearly the momentum has been with stocks, which is why the index is heavily weighted in equities at this time. If we start to see equities falter and volatility pick up, the portfolio will start to shift toward a more balanced allocation that will act as a hedge against the core stock exposure,” Fabian writes. “One of the drawbacks to a strategy such as PHDG is that it will underperform in a strong equity uptrend like we have experienced in 2013.”

He notes that Barclays S&P 500 Dynamic Veqtor ETN (NYSEArca: VQT), an exchange traded note, is a competitor to PHDG.

“As of today PHDG has only accumulated $66 million in total assets but I would not be surprised to see that number climb if stocks turn south,” he said. “This ETF will likely see strong inflows in the event of a sustained correction or bear market similar to asset flows into a traditional inverse fund such as the ProShares Short S&P 500 ETF (NYSEArca: SH).” [Short ETFs See Inflows on Fears Market Set for a Fall]

The opinions and forecasts expressed herein are solely those of John Spence, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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