3 ETFs That Will Help You Hedge Your Portfolio
David Fabian: Hedging your portfolio is a strategy that is often employed by those who want to take out some downside protection against the possibility of a market drop. The most successful application of this process is to reduce your exposure in highly appreciated long positions with the assets that demonstrate inverse or non-correlated properties to the broad equity market.
This will allow you the flexibility of reducing your risk profile without having to shift your holdings to cash or disturb your existing cost basis in a taxable account. Playing defense in the midst of a correction or even a bear market may help you sleep better at night knowing that your capital has some layer of protection from a measured move lower.
Exchange traded funds make for a very easy way to access this type of strategy because they provide instant, transparent, and low-cost access to a variety of asset classes. You can shape your hedge to reduce stock market risk, interest rate risk, commodity risk, or any combination of those major groups depending on your needs.
For instance, the ProShares Short S&P 500 ETF (SH) is a popular way to play an inverse relationship with the S&P 500 Index. SH is designed to move inverse (or short) the same percentage move as the S&P 500 Index on a daily basis. According to ETF.com, this fund has seen net inflows of $728 million from the beginning of the year through February 9. This should come as no surprise given the strong down draft in the market and rush for protection that many investors are trying to capitalize on.
Another popular strategy for hedging your stock market risk is to own long-duration Treasury bonds such as the iShares Barclays 20+ Year Treasury Bond ETF (TLT). This fund owns a concentrated basket of Treasuries with maturity dates greater than 20 years. The end result is a single vehicle that is highly sensitive to changes in interest rates. TLT won’t provide a perfect inverse relationship to the stock market, but there has been a historically high correlation of falling stocks coinciding with a rush to safety in Treasury bonds.
When fear of losses in paper assets set in, there is often a concomitant rush to own precious metals such as the SPDR Gold Shares ETF (GLD). This exchange-traded fund tracks the daily price movement of gold bullion and has been steadily climbing higher in 2016. Many investors have become disenfranchised with the multi-year downtrend in gold prices. However, the recent surge in the yellow metal, alongside swelling volume is a possible sign that those misfortunes are due to change.
Similar to TLT, gold bullion will not offer a perfect inverse correlation with the stock market and should be evaluated on its own technical and fundamental merits as an effective hedge for your specific portfolio.
Implementing A Hedge In Your Portfolio
It should be noted that adding exposure to non-correlated investments opens you up to the risk that the market once again resumes its climb and these hedges fall quickly in value.