By Daniela Pylypczak
When it comes to investing, the focus is always on maximizing returns. But as we continue to keep our eye on the prize, many investors sometimes forget about the importance of limiting downside risk.
Besides the obvious direct benefits, downside protection strategies can help us from falling into "behavioral traps" that can significantly erode returns. Every investor has experienced these behavioral traps--buying when we should be selling, selling when we should be buying, and continuously and illogically digging ourselves into deeper holes.
But thanks to the evolution of the ETF industry, a number of downside protection strategies are now within reach of the average investor. From low-volatility focused products to oscillatory rules-based funds, ETFs provide a variety of cost-effective avenues to easily and effectively limit downside risk.
Below we outline several ETP options for minimizing downside:
1. Volatility Response ETFs
Direxion recently debuted a suite of volatility response ETFs designed to adjust exposure to the stock market depending on currency conditions. The concept behind these funds is relatively simple: when the markets are experiencing high levels of volatility, many investors may choose to shift their exposure towards less risky securities, such as Treasury bills. During periods of low volatility, a larger tilt towards risky asset classes may prove to be quite lucrative.
S&P 500 RC Volatility Response Shares (VSPY)
S&P 1500 RC Volatility Response Shares (VSPR)
S&P Latin America 40 RC Volatility Response Shares (VLAT)
2. Low Volatility ETFs
There are now a number of low volatility ETFs, covering just about every slice of both domestic and international markets. These funds focus on stocks that have historically exhibited low volatility, and they will generally maintain a tilt towards more stable sectors [see also The Compelling (And Simple) Case For Low Volatility ETFs].
S&P 500 Low Volatility Portfolio (SPLV)
MSCI All Country World Minimum Volatility Index Fund (ACWV)
MSCI Emerging Markets Minimum Volatility Index Fund (EEMV)
MSCI USA Minimum Volatility Index (USMV)
Russell 1000 Low Volatility ETF (LVOL)
MSCI EAFE Minimum Volatility Index Fund (EFAV)
S&P Emerging Markets Low Volatility Portfolio (EELV)
S&P International Developed Low Volatility Portfolio (IDLV)
Russell 2000 Low Volatility ETF (SLVY)
Developed ex-U.S. Low Volatility ETF (XLVO)
3. TrendPilot ETNs
RBS's family of "TrendPilot" exchange-traded notes offer investors exposure to a dynamic trading strategy applied across a variety of asset classes. Each fund tracks a rules-based index that strategically shifts allocations based on a simple historical moving average. The strategy is relatively straightforward in that when an ETF's underlying index is at or above its 100-day simple moving average, the fund goes long the underlying securities. If, however, the index closes below the simple moving average for five consecutive sessions, the ETF will shift exposure to "safer" short-term U.S. Treasuries.
China Trendpilot ETN (TCHI)
US Large Cap Trendpilot ETN (TRND)
US Mid Cap Trendpilot ETN (TRNM)
Gold Trendpilot ETN (TBAR)
NASDAQ-100 Trendpilot ETN (TNQD)
Oil Trendpilot ETN (TWTI)
ETFdb offers a comprehensive and orignal ETF database and analytical consulting services for advisors and investors, as well as a free newsletter. Learn more about their services by visiting ETFdb.com. Disclosure: the author had no positions in the securities named in this article at the time of writing.