According to a recent study, more than half of the risk-managed strategies that underlie ETFs designed to manage losses during market turbulence failed to fare better than equities in 2022, including several strategies marketed as hedges against black swan-type events.
The study by consulting firm Global Finesse sampled a group of ETFs deemed to have “downside mitigation” strategies meant to limit losses in a market downturn in exchange for fewer gains when the equity market is positive. These risk-managed ETFs often use a combination of equity options, Treasurys, VIX futures contracts, and cash to protect against potential losses from stock market downturns.
Generally, the products appeal to conservative investors who want to protect their capital during downturns. 2022 was a natural experiment for these funds, given the year’s sharp inflationary pressure; energy and supply chain pressures caused by Russia’s invasion of Ukraine; ongoing economic shocks from the pandemic; and a Federal Reserve that consistently raised rates throughout the year.
Half of Risk-Managed Strategies Successful
However, the study shows half of the eight risk-managed ETFs it looked at had smaller losses than the 18% decline of the SPDR S&P 500 ETF Trust (SPY) in 2022: the ASYMmetric Smart S&P 500 ETF (ASPY), Innovator U.S. Equity Buffer ETF (BJAN), Invesco S&P 500 Downside Hedged ETF (PHDG) and the Cambria Tail Risk ETF (TAIL).
Over a two-year period where the S&P 500 gained 2.64%, ASPY, BJAN, and PHDG managed to meet their downside protection goals while meeting 90% of SPY’s returns. TAIL failed this test, posting a 12.8% loss during the period.
| ETF | 2022 Performance | 2-Year Performance | 2022 Flows |
| NUSI | -28.35% | -14.3% | -$87.4M |
| BJAN | -11.4% | 0.44% | $32.7M |
| ASPY | -10.94% | 2.47% | $5.54M |
| PHDG | -14.09% | -0.31% | -$35.7M |
| RPAR | -22.8% | -8.88% | -$182.5M |
| SPD | -25.96% | -18.52% | -$66.6M |
| SWAN | -27.78% | -16.97% | -$419.6M |
| TAIL | -13.13% | -12.8% | -18.3M |
Ultimately, the four funds that underperformed the S&P 500 last year failed primarily due to allocations to 10- and 30-year Treasurys as a safe haven from stock tumult. However, longer-term bonds have higher duration risks and a tendency to fall in price when interest rates rise.
The longer-run results come on top of hefty fees. Downside mitigation ETF expense ratios can range from around 0.4% to just under 1% due to their relatively complex operation.
Consider the Big Picture
Eugene Yeboah, a co-author of the study, noted that the relationship between the 10-year Treasury rate and equity returns could correlate or invert heavily based on the business cycle. That, in turn, affects other economic drivers, such as commodity prices or employment.
“All these dynamics come into play, and people don’t look at these factors, but there’s a dynamism between all these risk factors,” he said. “You can’t isolate one from the other.”
Richard Greene, a co-author of the study, said it’s overly simplistic to look at just one economic dynamic, such as volatility, when developing hedges against the downside or tail-risk event.
He pointed to ASPY, which measures its exposure to individual S&P 500 sectors by volatility as part of a more “dynamic” approach to fitting an ETF’s holdings to the rest of the market.
“When you’re trying to thread the needle between downside protection so you don’t lose nearly as much money as the broader equity market, but you also want to have positive returns in positive years as well, something that has more of that dynamic approach to it works far better than hard-coded approaches,” he said.
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