ETFs as a shield against market declines

In the last few weeks, we have witnessed a significant downturn in all markets around the world and the American one has certainly been no exception. ETFs can be a tool to hedge against the declines of the markets.

The market crash

The market has entered a correction phase that is aggravated by the composition of its value. 

The Nasdaq, for example, is made up of over 3000 stocks of which only ten make up 50% of the value of the index and the top two of these (Apple and Microsoft) are worth 21% while in the S&P 500 the seven stocks by value make up a quarter of the index. If we look at international indices, the correlation remains, i.e. a few stocks weigh a lot, for example the MSCI World, which is an index of stocks on the global stock market, is made up of 17.6% of the seven Big Techs. 

This exposure of the indices to a few large giants means that the health of these is the needle of the scales for the entire index and is a fundamental factor to take into account when considering a strategy of content/portfolio remodeling. 

It becomes fundamental to reduce risk exposure and protect one’s own portfolio from volatility. 

ETFs to hedge against market declines

We have seen how some investors (all or almost all) protect themselves against market correction and inflation by buying safe haven assets such as Gold and Bitcoin (even if with different characteristics) but this can only concern a part of the investments (let’s say about one third) for the rest we need to remodel. 

ETFs (Exchange Traded Funds) which are funds that replicate the performance of an index whose capital is safe (even in case of failure of those who issue the fund) are one of the most widely used tools to rebalance their exposure, in particular the smart beta ETFs offer immediate diversification thanks to the broad spectrum of the underlying. 

In addition to smart beta there are also low volatility funds that allow a greater exposure in more defensive sectors and consequently protect us in down phases of the market. Other funds such as low volatility/high dividend ETFs, also allow exposure to high dividend stocks, which is excellent in periods of low rates. 

To give a practical example, the S&P 500, compared to the low volatility ETF, loses 2% more in the short term, but in the long term, the results tend to approach the trend of the reference index. Finally, there are also equal funds that give the same weight to each security in the basket in order to eliminate the exposure mentioned at the beginning of this article. 

To compensate for losses, there are other instruments, such as Velocity Shares Daily 2x Vix Short Term ETN with exposure on Futures. Diverting some of one’s resources to Vix is an effective protection against the unpredictability of the markets. 

A solution for experts only

The possibility to speculate on a losing market is certainly the most effective solution but the most difficult, it requires a careful and constant monitoring that aims at very short term opportunities and therefore it is advisable only for expert investors (ETFs that go short even with leverage). 

In short, the key is diversifying and hedging in periods of correction, and in this sense, ETFs are a very valid ally.