Assume for the moment that the stock market has been terrible for an entire month. For small- and mid-sized corporate shares, it might be longer than that; for large-caps, the media had been hyping the all-time records on September 18. Regardless, it is fair to say that things have been rather torturous on a month-over-month basis. What might one have done to alleviate some of the pain? What types of assets could have hedged concerns that you may have had going into September?
Below are several ETFs that I often use to hedge against stock risk. I am providing month-over-month returns as well as corresponding 3-year correlations with Vanguard Total Market (VTI):
Month-Over-Month Returns And Correlation Data | |||||||
MOM % | 3 Yr Corr | ||||||
(W/ VTI) | |||||||
Vanguard Extended Duration (EDV) | 9.9% | -0.50 | |||||
iShares 10-20 Treasury (TLH) | 3.8% | -0.44 | |||||
CurrencyShares Japanese Trust (FXY) | 0.1% | -0.29 | |||||
SPDR Gold Trust (GLD) | 0.1% | -0.02 | |||||
Currency Shares Swiss Franc (FXF) | -2.1% | 0.11 | |||||
Vanguard Total Market (VTI) | -5.4% | NA | |||||
Indeed, if a correction is in the works, one might be advised to incorporate negatively correlated assets into his/her portfolio. Funds like Vanguard Extended Duration Treasury (EDV), iShares 10-20 Year Treasury and the Japanese Yen Trust (FXY) have negative correlations with Vanguard Total Market (VTI), providing an effective hedge against an ongoing erosion of stock price. Similarly, the Currency Shares Swiss Franc (FXF) and SPDR Gold (GLD) are non-correlated assets that have been marching to the beat of their own respective drums. While neither has made much headway in the month-over-month blood-letting for stocks, neither has depreciated as much in value as VTI.
It is hardly too late to hedge against a much larger correction for stock assets. Any of the above-mentioned five ETFs can be added to a portfolio to diversify, though an effective hedge might best be accomplished through the use of a “barbell” or a “multi-asset approach.” One can implement the barbell portfolio that I have been talking about since the beginning of the year. For simplicity sake, a barbell portfolio might involve long-maturity Treasuries like TLH and EDV in combination with large cap-oriented ETFs such as VTI and iShares S&P 100 (OEF).
The other consideration? Make room in the portfolio for more than Treasuries alone when hedging against stock risk. Consider the possibility of adding the Japanese yen, the Swiss franc and the yellow metal a la SPDR Gold (GLD). A multi-asset stock hedge coupled with three or four low-cost stock index ETFs is highly likely to reduce volatility as well as loss. By the same token, one is highly likely to achieve similar-risk reducing results with cash – cash raised by stop-limit loss orders.