ETF investors should consider a strategic hedge to the equities market along with a source of yield and returns to better manage future downside risks and still participate in any further upside potential.
On the recent webcast, Hedge or Seek Yield: What Advisors Need to Know, Kevin McCreadie, Chief Executive Officer & Chief Investment Officer at AGF Management Limited, and Bill DeRoche, Chief Investment Officer & Portfolio Manager at AGF Investments LLC, delved into ways to diversify and hedge against market volatility in a prolonged bull run.
The AGF Investments strategists pointed out that the equities market can experience wide oscillations in any given year, with the S&P 500 seeing a 10.8% decline during its worst before ending the calendar year with a -4.9% return.
Part of the greater volatility associated with these large benchmarks may be attributed to their traditional market capitalization-weighted indexing methodologies where the largest and historically best performing stocks now make up huge positions in these cap-weighted indices. For instance, the top 6 components of the S&P 500 now make up 17% of the benchmark’s total weight, compared to the bottom 290, which also only make up 17% of the index.
The strategists pointed out that institutional investors are concerned that the economic cycle is turning as many investors shifts away from equities in the near future. While the global trend is a move away from equities, we also witnessed a shift within equity portfolios to strategies with lower risk. Diversification and the inclusion of alternative investments have become more important as a traditional stock and bond portfolio mix may not provide the same type of returns investors have been accustomed to.
Consequently, investors should adapt their portfolio to be more diversified than before. Allocating strategically to proven equity market hedges is one way to potentially insulate a portfolio from unexpected market events and help compound wealth.
For the income-minded investor, the strategists argued that rates will remain low versus their long-term average. Meanwhile, valuations of many dividend equities are above historical norms due to strong returns and asset flows as many avoid fixed income exposure over concerns of a rising interest rate environment. Given the current low-yield environment coupled with heightened equity market volatility, income-seeking investors face unprecedented challenges.
Alternative investment strategies may be a good way for investors to diversify away from traditional equity and fixed-income allocations and still maintain upside potential. Alternatives provide diversification through low to non-correlated return sources; greater risk-adjusted returns; reduced volatility and risk; hedging against rising interest rates or inflation; downside protection and capital preservation.
Investors can look to something like the AGFiQ Global Infrastructure ETF (NYSEArca: GLIF) for exposure to the growing need for infrastructure spending. The infrastructure category has historically offered higher dividend yields than global fixed-income and global equities, along with greater predictability of long-term cash flows. The ETF may be able to capture the growing demands of economic developing that are driving more funding into transport, power and other systems, which require about $69.4 trillion globally, according to Mckinsey Global Institute.
Investors may consider the AGFiQ Hedged Dividend Income ETF (NYSEArca: DIVA), which tracks the INDXX Hedged Dividend Income Index, to capture strong current yield capital appreciation potential with a risk profile similar to a corporate bond index. The fund holds 100 equally weighted securities within the universe of the largest 1000 US stocks that have paid consistent or growing dividends and which have the highest dividend yields. Additionally, the fund shorts approximately 150 to 200 stocks, within the same universe, that have the lowest-to-no dividend history and low yields. Due to its indexing methodology, investors may find higher yields than dividend stocks while potentially hedging against volatility of equity markets.
Additionally, investors can look to the AGFiQ Dynamic Hedged U.S. Equity ETF (USHG) to better address volatility and risk management. The AGFiQ Dynamic Hedged U.S. Equity ETF provides exposure to a diversified portfolio of U.S. equities, while seeking to provide long-term capital appreciation with lower volatility using embedded downside risk management which seeks to protect capital. The ETF offers exposure to the long-term growth potential of U.S. equities using a multi-factor approach designed in an effort to have lower volatility and better risk-adjusted returns relative to the market through its use of a dynamic hedging model.
Financial advisors who are interested in learning more about strategies for the current market environment can watch the webcast here demand.