Rate cuts may prove a boon for fixed income this fall, but potential economic weakening creates a challenged outlook for equities. While the Fed seeks to navigate a soft landing for the economy, positioning portfolios defensively could provide some investor peace of mind. For investors looking to mitigation potential equity losses, the Parametric Hedged Equity ETF (PHEQ) is worth consideration.
This fall brings with it the potential for more short-term volatility as the U.S. presidential election draws nearer. Recession concerns and geopolitical risk also create the potential for volatility and drawdowns in the second half. Add in the Fed attempting to thread the needle on curtailing inflation without tipping the U.S. into a full-blown recession, and it creates a charged macro environment.
Hedge Against Potential Equity Losses With PHEQ
PHEQ seeks to provide capital appreciation while protecting against losses. PHEQ invests in U.S. large-cap stocks within the Solactive GBS US 500 Index while using options to hedge against drawdowns. The strategy optimizes the weights of its holdings to create a risk-and-return profile similar to that of the index.
The fund’s strategy led to reduced losses in the market sell-off at the beginning of August. The rapid collapse of the Japanese yen carry trade alongside elevated investor recession fears led to significant deleveraging and de-risking over the first days of August.
In the period between July 31 and Aug. 5, 2024, the S&P 500 Index declined 6.08%. Meanwhile, PHEQ fell just 3.52% over the same period, according to Y-charts data. The fund is currently up 9.46% on a total returns basis as of 8/21/24.
PHEQ employs a laddered options overlay strategy that sacrifices some upside potential for downside protection. The fund does so by using a put spread collar strategy wherein it buys close-to-the money protective puts and sells further out-of-the-money puts.
Any loss mitigation is limited to that which the put spread covers. The fund ladders the one-year options across quarters to allow for optimal downside protection and upside capture. PHEQ also writes calls, thereby earning a premium to offset the put spreads.
The fund engages in tax loss harvesting within its equity holdings to offset realized gains. It distributes a quarterly dividend and carries an expense ratio of 0.29%.
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