As the near year begins, the stock market has brought with it lots of volatility. And the crazy gyrations have given even the most bullish investors some pause.
The Cboe Volatility Index, also known as the “VIX,” based on the S&P 500, spiked 14% before settling down with an almost 8% gain in the period from January 1 through the market close yesterday (January 11). Meanwhile, broadly owned ETFs like the SPDR S&P 500 ETF (SPY) and Invesco QQQ Trust (QQQ) have fallen 1.10% and 3.02%, respectively, during the same period.
With the Federal Reserve expected to hike interest rates up to three times this year, it may be time for advisors and clients with heavy equity exposure to buckle up. Let’s examine a few ETF strategies for navigating the bumpy ride.
Buffered Outcome ETFs
ETFs with a buffering strategy are a new class of funds that limit an investor’s downside in tough markets. The trade-off is they also cap or limit the investor’s upside. But for some investors, muted gains are OK, as long as they can sleep at night.
Allianz Investment Management offers a lineup of buffered ETFs organized by a 10% or 20% downside buffer. The funds are then scattered across different months for different expiration periods.
For example, the AllianzIM U.S. Large Cap Buffer20 Jan ETF (AZBJ) provides 20% of downside protection on losses in the S&P 500 for the outcome period of January 1, 2022, to December 31, 2022. In exchange for the buffer, investors agree to a limit on the fund’s upside performance. The current upside cap is a maximum 7.90% gain for the S&P 500. AZBJ charges annual expenses of 0.74%.
Also known as “defined outcome ETFs,” funds with a buffering strategy offer a novel way for managing risk.
Inverse ETFs
Inverse performing funds are a different kind of product, first introduced in 1993. The category quickly grew to over 100 funds with $10 billion in assets. And in 2006 the first group of leveraged and inverse ETFs was launched.
The inverse 1X products are designed to provide 100% daily opposite exposure of the underlying index without leverage. The Direxion Daily S&P 500 Bear 1X Shares (SPDN), for instance, is built to deliver 100% of the daily opposite return of the S&P 500. That means if the S&P 500 is down by 2% on any given day, SPDN should increase by 2% in value. Conversely, if the S&P 500 climbs by 2%, then SPDN would fall by 2%.
Other ETF families like ProShares offer inverse performing ETFs linked to the Nasdaq-100 (PSQ), Dow Jones Industrial Average (DOG) and Russell 2000 (RMW).
Inverse ETFs cover many different equity yardsticks. They are another tool that advisors should keep on their radar for getting temporary protection from stormy markets.