Volatility is lately on the rise amid debt default worries. This is especially true as the second meeting between White House and Republican congressional negotiators has ended up with no progress on raising the federal government's $31.4 trillion debt ceiling. And a deadline to raise the borrowing cap is fast approaching.
A default on its debt would likely mean a recession for the U.S. economy. In such a scenario, investors should apply some hedging techniques to their equity portfolio to reduce the overall volatility or protect against significant market downturns. While there are a number of ways to do this, volatility-hedged ETFs seem compelling choices. Some of these include Global X Russell 2000 Covered Call ETF RYLD, iMGP DBi Managed Futures Strategy ETF DBMF, Aptus Drawdown Managed Equity ETF ADME, Invesco S&P 500 Downside Hedged ETF PHDG and First Trust Managed Futures Strategy Fund FMF.
Investors should note that these funds have the potential to stand out and outperform simple vanilla funds in case of rising volatility.
What Are Volatility Hedged ETFs?
Volatility hedged ETFs are investment products designed to mitigate the impact of market volatility on a portfolio. These ETFs typically aim to provide investors with exposure to a particular asset class or market while reducing the impact of price fluctuations resulting from market volatility (read: Tech ETFs Roaring to New 52-Week Highs).
The basic premise behind volatility-hedged ETFs is to combine a long position in an underlying asset or market with a short position in volatility futures or options contracts. By shorting volatility, these ETFs attempt to offset or "hedge" the potential losses that may occur during periods of heightened market volatility.
These ETFs are often structured to provide targeted exposure to specific markets, such as equities or fixed income, while attempting to reduce the impact of volatility on returns. They may employ various strategies and techniques, including options, futures contracts, and other derivatives, to achieve their objective.
However, these ETFs may not always provide complete protection during extreme market events, and they may have additional costs associated with their hedging strategies.
Debt Ceiling Talks Fail
Over the weekend, House Speaker Kevin McCarthy accused White House officials of backpedaling in negotiations on raising the debt ceiling and setting federal spending levels. The U.S. government is nearing the Jun 1 deadline, when the government could run out of cash to pay its bills, unless Congress allows it to borrow more (read: Wall Street On the Brink of Rally? Momentum ETFs to Tap).
U.S. President Joe Biden on Sunday called the latest Republican offer on lifting the debt ceiling “unacceptable." Republicans said they would not approve an increase in the federal government's borrowing limit without agreement on sharp spending cuts.
ETFs in Focus
Global X Russell 2000 Covered Call ETF (RYLD)
Global X Russell 2000 Covered Call ETF seeks to generate income through covered call writing, which historically produces higher yields in periods of volatility. It follows a “covered call” or “buy-write” strategy, in which the fund buys the stocks in the Russell 2000 Index (at times by exposure to the Vanguard Russell 2000 ETF), and “writes” or “sells” corresponding call options on the Russell 2000 Index.
Global X Russell 2000 Covered Call ETF has AUM of $1.4 billion and trades in an average daily volume of 1.4 million shares. The ETF charges 60 bps in fees per year.
iMGP DBi Managed Futures Strategy ETF (DBMF)
iMGP DBi Managed Futures Strategy ETF seeks long-term capital appreciation. It will employ long and short positions in derivatives, primarily futures contracts and forward contracts, across the broad asset classes of equities, fixed income, currencies and commodities.
iMGP DBi Managed Futures Strategy ETF has AUM of $708.5 million and charges 85 bps in annual fees. It trades in a moderate volume of 425,000 shares a day on average.
Aptus Drawdown Managed Equity ETF (ADME)
Aptus Drawdown Managed Equity ETF seeks capital appreciation with a focus on managing drawdown risk through hedges. The strategy typically selects 50-75 large U.S. companies based on a Yield plus Growth framework, tilting holdings to favor companies with solid fundamentals and reasonable valuations while avoiding those with negative price momentum. It has an added objective of capital protection through the use of equity and index options to reduce drawdown when U.S. equity markets are falling.
Aptus Drawdown Managed Equity ETF charges 79 bps in annual fees and has accumulated $195.2 million in its asset base. It trades in an average daily volume of 44,000 shares.
Invesco S&P 500 Downside Hedged ETF (PHDG)
Invesco S&P 500 Downside Hedged ETF is an actively managed fund that seeks to deliver positive returns in rising or falling markets that are not directly correlated to broad equity or fixed-income market returns. Invesco S&P 500 Downside Hedged ETF tries to follow the S&P 500 Dynamic VEQTOR Index, which provides broad equity market exposure with an implied volatility hedge by dynamically allocating between different asset classes: equity, volatility and cash. The index allows investors to receive exposure to the equity and volatility of the S&P 500 Index in a dynamic framework (read: Don't "Sell in May And Go Away," Consider 5 ETF Strategies).
Invesco S&P 500 Downside Hedged ETF has accumulated $191.1 million in its asset base and charges 39 bps in fees per year from its investors. Volume is good, exchanging 44,000 shares a day on average.
First Trust Managed Futures Strategy Fund (FMF)
WisdomTree Managed Futures Strategy Fund seeks to achieve positive returns that are not directly correlated to broad market equity or fixed income returns by investing in a portfolio of exchange-listed futures.
First Trust Managed Futures Strategy Fund has accumulated $170.6 million and charges 95 bps in annual fees. It trades in a moderate volume of 46,000 shares a day on average.
Investors can shield their portfolios against volatility with the help of the above-mentioned products. These provide dynamic exposure according to the level of market volatility and are least affected by any market turmoil. So, they could prove to be great choices when it comes to offering protection against market downturns.
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