As investors try to hedge their portfolios or try to enhance returns in an extended bull market environment, consider tactical alternative exchange traded fund strategies.
On the recent webcast (available on-demand for CE Credit), Systematic Tactical Management with Leveraged ETFs, Sylvia Jablonski, Managing Director and Institutional ETF Strategist at Direxion, argued that advisors should look at leveraged and inverse ETFs to hedge rising risks in an extended bull market. These leveraged and inverse ETFs try to magnify the returns of their benchmarks on a daily basis.
Leveraged and inverse ETFs “allow investors to gain exposure without the need for full dollar-for-dollar investment,” Jablonski said.
Investors should also keep in mind that most leveraged ETFs are designed to produce double or triple the performance of the underlying market on a daily basis. Consequently, when investors look at the long-term performance of a typical leveraged ETF, people may notice that the fund may not perfectly reflect their intended strategies.
A market without long interruptions and relative lack of volatility will help maintain positive gains in a leveraged ETF. Since the ETFs rebalance on a daily basis, compounding effects benefit leveraged ETFs in a consistently trending market. On the other hand, in times of increased volatility, leveraged ETF returns can fall behind their intended 2x or 3x strategies.
“The reason for this is that volatility combined with leverage and compounding leads to decay,” Jablonski said. “In pursuit of their daily investment objectives, leveraged ETFs must rebalance their assets to exposure ratio on a daily basis. This means that their returns over time are the product of a series of daily returns, and not the fund’s beta multiplied by the cumulative return of the index for periods greater than a day. This deviation in performance is commonly referred to as compounding.”
Consequently, potential leveraged and inverse ETF traders should closely monitor their positions. During highly volatile periods for a fund’s benchmark index, you will need to adjust your positions frequently to maintain constant exposure levels. During periods of lower volatility for the benchmark index, you should continue to monitor, but position adjustments will likely be needed less frequently.
“Daily rebalancing funds are not meant to be held, unmonitored for long periods,” Jablonski said. “If you intend to hold leveraged ETFs for periods greater than a day, you must always watch them closely.”
Direxion leveraged and inverse ETFs are a tactical trade idea for sophisticated traders looking to express an opinion on volatility.
Expanding on the need to closely monitor leveraged and inverse ETF trades, Luke Carlson, Director of Business Development & Partner at QST Capital, highlighted the wide peak and troughs among bearish market conditions. For instance, in the most recent 2008 financial downturn, markets experienced a 56% decline from peak to trough. Consequently, Carlson argued that it is more prudent to utilize these types of products to hedge a part of a portfolio.
“Don’t focus on achieving 100% of upside. Capture a portion,” Carlson said.
Moreover, Kyle Shealer, Chief Investment Officer & Partner at QST Capital, advised investors to maintain an unbiased or rules-based approach with leveraged and inverse ETFs so as to limit emotional trades that could do more harm than good.
Looking at current market conditions, traders may have targeted the financials segment as the Federal Reserve looks to hike interest rates and the Trump administration promises deregulation and tax cuts. Traders seeking to capitalize on the shifts may look to short-term options like the Direxion Daily Financial Bull 3X Shares (NYSEArca: FAS) and Direxion Daily Financial Bear 3X Shares (NYSEArca: FAZ).
Jablonski pointed to leveraged and inverse Treasury ETFs, like the Direxion Daily 20+ Year Treasury Bull 3x Shares ETF (NYSEArca: TMF) and Direxion Daily 20+ Year Treasury Bear 3x Shares ETF (NYSEArca: TMV), for short-term and long-term hedging with changes in the fixed-income landscape. For instance, a 1% rise in interest rates would be more detrimental to longer duration bond positions, so investors may implement an inverse hedge for a rising rate environment.
The overvaluation of FANG stocks, which led to a sharp sell off in June, has revealed an opportunity in tech names. The technology sector has been among the best performing areas of the market this year as growth- and momentum-driven stocks lead the post election rally. However, as we recently witnessed, the Direxion Daily Technology Bear 3X Shares (NYSEArca: TECS) and Direxion Daily Technology Bull 3X Shares (NYSEArca: TECL) could help traders ride the twists and turns in the technology sector.
Additionally, the Direxion Daily S&P Oil & Gas Exploration & Production Bull 3x Shares (NYSEArca: GUSH) and Direxion Daily S&P Oil & Gas Exploration & Production Bear Shares (NYSEArca: DRIP) can help traders gain exposure to the swings in the crude oil industry after oil prices plunged and seek to consolidate in light of ongoing concerns over a global supply glut.
Financial advisors who are interested in learning more about alternative tactical investment strategies can watch the webcast here on demand.