The sudden global shock of the coronavirus outbreak is a stark reminder about the fragility of both global markets and human life.
In his book entitled, “Antifragile: Things That Gain from Disorder," author Nassim Taleb describes unpredictable shocks and other chaotic events that arise. These occurrences are sometimes referred to as “black swans” that trigger plunging asset prices and skyrocketing volatility.
In this article, we’ll examine fragility and look at ETF strategies for combating it.
Fragile vs. Antifragile Investing
The "fragile" portfolio is vulnerable to sustained volatility and sharp setbacks. Opposite of fragile are things that resist the dangerous forces of fragility. Moreover, these things go one step further by thriving on chaos. We can describe these kinds of investments as “antifragile.”
The benefits of employing antifragile strategies are only appreciated when everything seems to go wrong. Instead of cracking during times of enormous chaos, surging volatility and a multiplicity of disorder, the antifragile portfolio actually benefits.
Inverse ETFs are one example of antifragile investments because they are designed to increase in value when market prices fall. How have they performed?
Since mid-February, the SPDR S&P 500 ETF (SPY) has cratered 21% while inverse ETFs in the form of the ProShares UltraShort S&P 500 ETF (SDS) and the Direxion Daily S&P 500 Bear 1x Shares (SPDN) have climbed 24.3% and 16.6%, respectively. SDS aims for double daily opposite exposure to the S&P 500 Index whereas SPDN aims for 100% daily opposite exposure to the same yardstick.
Beyond equities, inverse ETFs cover an array of asset classes including bonds, commodities, real estate and currencies. This allows advisors to deliberately target asset classes where clients may benefit from an antifragile approach.
Put options are another antifragile tool. Instead of being damaged when market prices collapse, put options thrive and even grow during external shocks. While not all ETFs have an active put options market, many large ETFs do have underlying put options. This feature provides trading flexibility and enables advisors to capitalize on chaos versus being hurt by it.
Volatility linked ETFs are another example of antifragile investments. The ProShares VIX Short-Term Futures ETF (VIXY), for example, has skyrocketed since mid-February as stocks sharply fell. VIXY has surged 220.8% during this period, illustrating how chaos has been beneficial for this fund.