With stocks significantly below 2018’s record highs and sentiment shifting more negative heading into 2019, investors and advisors have been focusing on strategies to safeguard portfolios and reduce losses relative to equity benchmarks.
Opinions certainly vary on whether this is the beginning of a deeper bear market or an overdone selloff within a bull market that has legs to run. What is less arguable is that today’s ETF investors sit in a much better place than in previous downturns (e.g., 2008, 2011). The lasting impact of the global financial crisis and the growth of the ETF industry have given rise to a host of ETFs that seek to reduce downside risk to the equity markets, while still allowing for upside growth. We list some of these ETFs below:
1. Innovator S&P 500 Defined Outcome ETFs
The Innovator Defined Outcome ETFs hit the scene in summer 2018 and have gathered a good deal of attention amidst the selloffs of the 4th quarter, with more than $150 million across the series, much of it coming in recent weeks. These first-to-market structured product-like ETFs use options strategies to provide upside exposure to the S&P 500 (to a cap), with defined buffers of 9% with the Innovator S&P 500 Buffer ETF (Cboe: BJAN), 15% with the Innovator S&P 500 Power Buffer ETF (Cboe: PJAN) or 30% with the Innovator S&P 500 Ultra Buffer ETF (Cboe: UJAN) over a one year period, gross of the .79% expense ratio. (For example, if the market is down -16% at the end of 2019, BJAN investors should be down -7% while PJAN investors should only be down -1% before fees.)
In times of elevated market volatility, the upside caps on the Defined Outcome ETFs are typically higher. Innovator estimates the pending January Series, scheduled to start trading January 2nd, will offer caps ranging from 16.78%-25.49% for BJAN; 11.42%-15.65% for PJAN; and 10.47%-12.75% for UJAN.
How many Wall Street forecasters see the S&P 500 up over 15%, let alone 20% in 2019? These ETFs allow investors to gain exposure to the stock market, knowing they have specific downside buffers to mitigate losses and a good level of upside participation should the market finish the outcome period in the black. Not a bad tradeoff for investors looking for a shield from potential US stock market losses.
The sponsor, Innovator Capital Management, headed by PowerShares founders Bruce Bond and John Southard, is launching a quarterly series, allowing investors to align their portfolios and exposures more closely with their market views and risk tolerance levels. The January Series of Innovator’s Defined Outcome ETFs are set to launch January 2, 2019.
2. Invesco S&P 500 Downside Hedge ETF (NYSEArca: PHDG)
PHDG takes a different approach to equity risk management, providing investors with exposure to the domestic stock market with an implied volatility hedge, dynamically allocating between equities, VIX Futures and cash. The actively managed ETF with $23.5 million and a .39% expense ratio seeks to achieve positive total returns in rising or falling markets that are not directly correlated to broad equity or fixed income market returns, according to the sponsor. Since launch in December 2012, the ETF has outpaced the HFRX Global Hedge Fund Index.
3. iShares Edge Min Vol USA ETF (CBOE: USMV)
Seeing some of the highest inflows in 2018, USMV provides investors exposure to stocks that exhibit a historically lower level of volatility relative to the broader US stock market. Launched in 2011, the $18.3 billion ETF with a .15% expense ratio invests in more defensive names and/or sectors to tamp down on standard deviation. In choppy sideways markets, the ETF affords investors a smoother ride, but in a deeper drawdown may expose investors to relatively more of the market’s downside due to the lack of a constant risk management or hedging mechanism.
4. DeltaShares S&P 500 Managed Risk ETF (NYSEArca: DMRL)
For investors seeking a more dynamic risk management mechanism designed to preserve capital during severe sustained market declines, DMRL from Transamerica is worth a look. DMRL offers ETF investors a managed risk approach to U.S. equity investing that has been honed in the institutional space. Launched in 2017, the passive, rules-based strategy tracks the S&P 500 Managed Risk 2.0 Index. With $377 million and a .35% expense ratio, DMRL seeks to stabilize volatility and reduce losses relative to the S&P 500 Index by allocating to 5-year Treasuries and/or cash when realized volatility exceeds a set threshold. Should volatility subside in 2019, DMRL’s dynamic approach to risk management is intended to allow investors to capture significant upside in calmer rising markets.
Many believe markets will remain under pressure in 2019 as worries about flagging global growth, tightening financial conditions and geopolitics induce further volatility. Thankfully, ETF investors have an increasing arsenal of options to decrease downside exposure and weatherproof portfolios.
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