Equities have been moving in lockstep, contributing to wide market swings. Consequently, investors should consider alternative exchange traded funds that exhibit low correlations to diversify away from rising volatility in traditional assets.
“After years of low correlations in a post-QE world, we are now entering a regime where higher correlations are feeding higher volatility. In my view, higher volatility (compared to 2017) is here to stay. Increasing stock correlations within equities are additionally making it harder for investors to look for diversification by simply investing in equities. Thus, beating markets through simple stock selection is getting harder,” WisdomTree Strategist, Gaurav Sinha, said in a research note.
Since mid-January, we’ve witnessed a sharp acceleration in stock correlations, which poses a severe challenge for investors from a de-risk standpoint. Sinha argued that the higher correlations across equities led to higher VIX levels in the following months and could potentially act as a signal for spikes in the VIX as well as wider or more wild swings.
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Looking ahead, Sinha believed that higher market volatility is here to stay, and the heightened correlations among traditional stock picks are making it more difficult for investors to diversify within the equity market.
On the other hand, investors may consider alternative strategies that do not exhibit high correlation to traditional assets. For example, investors may turn to investment strategies that have the potential to generate income by selling volatility and offsetting some losses if equities were to go through a downturn. Exposure to alternatives could provide better diversification and could defensively position a traditional portfolio mix in the current market environment.
ETFs for Alternative Exposure
Specifically, something like the WisdomTree CBOE S&P 500 PutWrite Strategy Fund (NYSEArca: PUTW), which tries to reflect the performance of the CBOE S&P 500 PutWrite Index, can help investors generate income by selling volatility through writing options. A put write strategy on the S&P 500 Index. PUTW includes one- and three-month Treasury bills and sells or “writes” one-month, at-the-money, S&P 500 Index puts. Investors can use PUTW to help lower portfolio beta and reduce downside risk. The strategy can generate higher potential income if the VIX stays elevated, and the income generated can offset potential losses if equities pulled back, especially in a highly correlated and volatile market.
Additionally, investors can turn to long/short strategies, such as the WisdomTree Dynamic Long/Short U.S. Equity Fund (DYLS) and the WisdomTree Dynamic Bearish U.S. Equity Fund (DYB), which hedge and seek to provide market-neutral and bearish positioning, respectively, in markets where fundamentals are deteriorating. These alternative ETF strategies can help investors by diversifying exposure in declining markets or limit downside risk.
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