The markets are likely in for a volatile year. Nevertheless, exchange traded fund investors have a few options to help diminish portfolio risks and help hedge against the swings.
Russ Koesterich, Global Chief Investment Strategist and Head of the Model Portfolio & Solutions Business at BlackRock, attributes the market volatility to a number of factors, including swings in the energy markets, evidence of economic deceleration in the U.S., poor economic data and uncertain financial market conditions.
“With central banks’ tools struggling to stimulate growth, markets are likely to remain volatile,” Koesterich said.
Consequently, Koesterich advises investors to look to tools to minimize downside risk.
For example, investors can consider low-volatility ETF strategies that provide exposure to the equities market but diminish the risks. Options include the iShares MSCI USA Minimum Volatility ETF (NYSEArca: USMV), which selects low-volatile stocks based on variances and correlations along with other risk factors, [An ETF Strategy for Uncertain Times]
The PowerShares S&P 500 Low Volatility Portfolio (NYSEArca: SPLV) is the main competitor to iShares’ USMV. SPLV, though, simply tracks the 100 least volatile stocks taken out of the S&P 500.
Additionally, the SPDR Russell 1000 Low Volatility Focus ETF (NYSEArca: ONEV) tracks large-cap U.S. stocks that demonstrate a combination of high value, high quality and low size characteristics, with a focus on low volatility.
The low-vol ETFs have outperformed or at least not done as poorly as broader benchmarks. Year-to-date, USMV dipped 4.1%, SPLV was down 4.1% and ONEV fell 7.1%, whereas the S&P 500 declined 9.2%.
“Minimum volatility strategies – which, as the name suggests, historically offer lower peaks and valleys than the market at large – can help mitigate risk,” Koesterich said.
Investors can also turn to preferred stock ETFs to help generate a yield to cushion against potential turns. For example, the iShares U.S. Preferred Stock ETF (NYSEArca: PFF) has a 5.82% 12-month yield, PowerShares Preferred Portfolio (NYSEArca: PGX) has a 5.89% 12-month yield, Global X SuperIncome Preferred ETF (NYSEArca: SPFF) has a 7.59% 12-month yield, First Trust Preferred Securities and Income ETF (NYSEArca: FPE) has a 5.98% 12-month yield and SPDR Wells Fargo Preferred Stock ETF (NYSEArca: PSK) has a 5.37% 12-month yield.
“Another theme we would embrace: seeking income sources that can provide at least some cushion when the markets are gyrating,” Koesterich added. “Specifically, preferred stocks are currently providing a mid-single-digit yield with more modest volatility.”
Income investors may like preferred stock ETFs since the asset class offer stable dividends, don’t come with taxes on qualified dividends for those that fall into the 15% tax bracket or lower, are senior to common stocks in the event liquidation occurs, are less volatile than bonds and provide dividend payments before common shareholders.
Preferred stocks are a type of hybrid security that show bond- and equity-esque characteristics. The shares are issued by financial institutions, utilities and telecom companies, among others. Within the securities hierarchy, preferreds are senior to common stocks but junior to corporate bonds. Additionally, preferred stocks issue dividends on a regular basis, but investors are unlikely to enjoy capital appreciation on par with common shares.
Max Chen contributed to this article.