The string of financial crises in recent years has been etched on the market’s psyche. As a way to mitigate oscillations in their portfolios, investors are turning to a number of low-volatility exchange traded fund options to hedge against potential risks down the road.
Low-volatility strategies tend to underperform during a bull market, but during times of market uncertainty, these types of investments can provide decent risk-adjusted returns.
One of the most popular option has been the PowerShares S&P 500 Low Volatility ETF (NYSEArca: SPLV), which garnered almost $3.1 billion since its launch in May 2011. SPLV holds the 100 stocks of the S&P 500 Index that has shown the lowest realized volatility over the last year. [Low-Volatility ETFs: The New Safe Haven]
Still, with the ever expanding universe of ETFs, investors have other tools on hand. For instance, the Direxion S&P 500 DRRC Volatility Response Shares (NYSEArca: VSPY) tackles the volatility issue through another methodology as a way to generate a greater risk/return portfolio.
Specifically, VSPY mitigates risk by changing its equity exposure to the S&P 500 based on a volatility index. The fund’s equity exposure is calculated by dividing the target volatility of 15% by the S&P 500’s volatility. Consequently, depending on the volatility level, VSPY can take on a cash position in T-Bills of 0% to a little over 80%.
More recently, two “tail” or “downside” hedged ETFs have been launched: the First Trust CBOE S&P 500 VIX Tail Hedge Fund (NYSEArca: VIXH) and PowerShares S&P 500 Downside Hedged Portfolio (NYSEArca: PHDG). Both funds will shift its position in the S&P 500 and call options on VIX futures, based on current market volatility. [PowerShares Readies ‘Downside Hedged’ ETF]
The tail hedging strategy protects a portfolio from extreme market oscillations due to unpredictable, random and unexpected events, or “Black Swan” events. The term was coined in a 2007 book by Nassim Nicholas Taleb published right before the financial crisis hit.
For more information on low-volatility funds, visit our low-volatility category.
Max Chen contributed to this article.