The fund, which has a 0.99 percent expense ratio, has somewhat proved its mettle in its short life. Since inception, it has shed only 0.48 percent of its value, according to Hamman, compared to a 4.14 percent gain for the S&P 500. A purely inverse fund would have slipped by around four percent in that time. The real test for this ETF, as with the other bearish ETFs discussed here, will come when the market begins to move sideways or heads down.
The Hybrid Approach
The WisdomTree Dynamic Bearish Fund (DYB) takes a more nuanced—and complex—approach to defensive investing. The fund pairs a long position in 100 U.S. stocks with a market capitalization of least $2 billion and that score high on growth and value metrics, while also deploying a corresponding short position in the S&P 500.
And here’s where things get tricky. If the broader market looks bearish relative to historic growth or valuation metrics, then the long part of the portfolio may be ratcheted down, potentially all the way to a zero percent weighting, leaving behind a 100 percent short component and Treasuries replacing the original long component.
On the flip side, if growth and valuation metrics are currently scoring well relative to historical trends, then the long side of the portfolio stays on, along with a 75 percent hedge. Thus, net equity exposure of the fund can vary from 25 percent in attractive environment to -100 percent in a bearish environment. “Right now, the hedging indicator is not on,” says Gaurav Sinha, asset allocation strategist at WisdomTree.
This fund, which has a 0.48 percent expense ratio, launched in late 2015 and has yet to have a chance to prove its worth in a flat or down market. So how can we know how this complex approach will fare? Sinha notes that WisdomTree cannot share data about historical testing data to the general public and instead only to financial professionals. But he does say that “the back-testing [during past market downturns] gave us the confidence to utilize this approach.”
This ETF’s exposure to long positions helps it hold up better in bull markets than purely short-focused funds. For example, it has risen 6.2 percent in the past 12 months (even as the S&P 500 has zoomed ahead 18.8 percent in that time).
Being On Guard
While the very long bull market continues unabated as we enter the year’s home stretch, that in and of itself should be a cause for concern because nothing lasts forever and the stock market often corrects itself on short notice. In other words, the current bullish mindset that has lifted U.S. equities to record highs means that a lot of investors will likely get caught with their pants down around their ankles when a correction—bear market or otherwise—finally occurs. Now is a good time to start exploring more defensive options to deploy when the bear begins to prowl.
For financial advisors looking to add bear-market protection to client portfolios, a big question becomes how to go about it. “It certainly depends on the advisor and their client’s risk tolerance,” Hamman says. “We primarily engage with advisors who employ HDGE and DWSH to reduce volatility as part of a long/short domestic equity strategy, which can range anywhere from a five to fifteen percent allocation of an overall portfolio.”