Downside hedged ETFs
Introduction
Historically, stock market ETFs and stock market indexes generally remained invested in the stock market at all times. In the past few years, several ETFs have been developed based on indexes that attempt to dynamically exit the stock market when the stock market is in a down turn. We call these ETFs "downside hedged" ETFs.
The stock market crash in 2008 reminded everyone that stock markets are volatile, but most people also know that it is very difficult to "time the market". These downside hedged ETFs are tracking indexes that are using different strategies to determine when they are going to exit the market during the next down turn. Who knows what "secret sauce" will work?
Please note that many actively managed ETFs give their portfolio manager the freedom to make investment decisions, including whether to be invested in the market at all times. For purposes of this article about "downside hedged ETFs", we are focused solely on ETFs that track an index, even though many actively managed ETFs may also judgmentally try to downside hedge their portfolio.
Will it work?
Downside hedged ETFs did not exist in 2007 and 2008, when the last market crash occurred. So we have no real life experience with downside hedged ETFs.
Some of these downside hedged ETFs are using complex strategies to determine when to exit and re-enter the market. But you wonder whether a simple strategy would work. For example, S&P has an index called the S&P 500 Trend Allocator Index that selects the stocks from the S&P 500 Index, but exits the market if the last five consecutive closing levels of the S&P 500 Total Return Index are below the 200 day simple moving average on each of the five respective consecutive days. The index does not re-enter the market until there have been five consecutive days of the S&P 500 Total Return Index values being above the 200 day simple moving average.
The S&P 500 Trend Allocator Index has performed well, as it exited the market in 2008 to avoid the worst of the stock market crash. But the question is whether it will do well when the next crash occurs. The index was launched on November 2, 2015, so the performance shown in the graph above is all based on theoretical back-testing data. Who knows if S&P had the benefit of hindsight, and only came up with the formula for the index because they knew it would have worked during the 2008 crash? Who knows if the formula of exiting the market when the S&P 500 Index has been below its 200 day simple moving average for five consecutive days will work in the future?
That's the challenge with most of these downside hedged ETFs. They are using strategies and indexes that are mostly theoretical, and they are based on back-tested indexes. Who knows what will work during the next down turn?
These ETFs underperform during strong bull markets
Note that one drawback to these downside hedged ETFs and indexes is that during a strong bull market they may lag the market, because they may exit the market during a short-term dip in the market, when they really don't need to. The S&P Trend Allocator Index, for example, exited the market a couple of times during 2015 and early 2016, and by the time the index re-entered the market, the index was too late - the S&P 500 Index had already significantly rebounded. So dynamically exiting the market pays off when a crash occurs, but you pay for it during a strong bull market.
There are a number of downside hedged ETFs in our database:
| Name | Symbol | Last price | Currency |
|---|---|---|---|
| Innovator IBD 50 ETF | ARCX:FFTY | 29.84 | USD |
| VanEck Vectors NDR CMG Long Flat Allocation | ARCX:LFEQ | 50.48 | USD |
| Pacer Trendpilot Fund of Funds ETF | ARCX:TRND | 33.35 | USD |
| HCM DEFENDER 500 INDEX ETF | ARCX:LGH | 52.74 | USD |
| Invesco S&P 500 Downside Hedged ETF | XNYS:PHDG | 38.14 | USD |
| HCM DEFENDER 100 INDEX ETF | ARCX:QQH | 68.71 | USD |
| First Trust Dorsey Wright Dynamic Focus | XNAS:FVC | 36.94 | USD |
| Global X Adaptive U.S. Risk Management ETF | ARCX:ONOF | 35.60 | USD |
| Alpha Architect Value Momentum Trend | BATS:VMOT | 26.00 | USD |
| VictoryShares US Discovery Enhanced Vola | XNAS:CSF | 55.65 | USD |
| Pacer Trendpilot US Large Cap ETF | BATS:PTLC | 54.24 | USD |
| Pacer Trendpilot US Mid Cap ETF | BATS:PTMC | 37.29 | USD |
| TrimTabs ETF Trust Donoghue Forlines Risk Managed Innovation ETF | BATS:DFNV | 37.72 | USD |
| Pacr Trndpilt 100 | XNAS:PTNQ | 76.11 | USD |
| INNOVATOR IBD BREAKOUT OPPS | ARCX:BOUT | 40.13 | USD |
| Timothy Plan US Large/Mid Cap Core Enhanced ETF | ARCX:TPLE | 25.75 | USD |
| SCHWAB 1-5 YEAR CORPORATE BO | ARCX:SCHJ | 24.32 | USD |
| VictoryShares US 500 Enhanced Volatility | XNAS:CFO | 69.39 | USD |
| Pacer Trnptm Etf | BATS:PTEU | 24.80 | USD |
| VictoryShares US EQ Income Enhanced Vola | XNAS:CDC | 62.42 | USD |
| ADVISORSHARES D/W FSM CORE | XNAS:DWUS | 48.87 | USD |
| Pacer WealthShield | BATS:PWS | 31.10 | USD |
| TrimTabs ETF Trust Donoghue Forlines Tactical High Yield ETF | BATS:DFHY | 21.43 | USD |