With the financial markets at precarious levels and risks coming from all over the world, here are our best alternative ETFs to reduce some risk in an investment portfolio. They will not eliminate risk but used in coordination with raising cash levels and inverse ETFs, can provide some downside protection against a severe bear market.
The Best Alternative ETFs for 2016
The PowerShares S&P 500 Downside Hedged ETF tops our list of best alternative ETFs. Every time I look at my stock screen during market sell-offs, PHDG seems to be holding up well. And for good reason. This actively managed fund allows investors to gain market exposure to the S&P 500 index while embracing volatile periods in the market. The fund dynamically switches between equity, volatility (VIX futures) and cash based on quantitative directives. Few investments are as manic as volatility futures and it is nice to know that a professional is reviewing the allocations on a daily basis. Monitoring the shape of the volatility curve and the dynamic nature of the contracts swinging from backwardation to contango is best left to the pros. The fund PHDG aims to have positive returns in both bull and bear markets. The fund has a low net expense ratio of just 0.40%. Given the fact that the fund is allowed to go to 100% cash, this low expense ratio seems reasonable. You wouldn’t want to be paying 2% to potentially sit in cash.
ProShares ETF, ticker RALS is a long short fund and is basically a hybrid between a smart beta fund and a hedged equity fund. The fund invests in the Research Affiliates Fundamental Index, instead of traditioanl market weighted indexes, for equity exposure. In fact, the fund shorts the Russell 1000 large-cap index. As of February 19the funds top ten short positions include names lthat comprise large parts of the market cap weighted Russell 1000 including like Starbucks, Apple, Cisco, Visa and Alphabet. The fund has a 0.95% expense ratio. This fund invests in the theory that market cap weighted indexes are inherently overvalued. The long positions based on their metrics are AT&T, GE, Chevron, JP Morgan and Time Warner Cable. As of February 19, the fund was very close to being ‘market neutral‘ with roughly $59.3 billion long and $58.7 billion short.
This defensive pick is the second Invesco PowerShares fund to make the list is the Standard & Poor’s Low Volatility Fund invests in securities that have the lowest realized volatility over the last twelve months, as compiled by Standard & Poor’s. The fund purports to capture 73% of market upside but just 43% of the downside. The fund leans heavily on defensive sectors like consumer staples and top holdings include Coca-Cola, PepsiCo, General Mills, Church & Dwight and Clorox. Shifting into defensive sectors is one way to help protect an investment portfolio from a severe market sell-off. They may still lose some value but they will hold up much better than highly cyclical growth sectors.
For international exposure, we like the European Hedged Equity Fund, HEDJ. The fund invests in European equities while attempting hedge fluctuations between the Euro and U.S. dollar. The fund also has a defensive tilt (its largest sector is consumer staples) which are export-oriented. Major components include Anheuser-Busch Inbev and Unilever. As the Euro weakens, which we expect, these companies will be able to increase exports, all else equal. European stocks offer the international exposure a well-diversified portfolio needs but hedges out the Euro currency which may be doomed for failure. A unified currency for a group of nations who have had military conflicts for 1500 years seems destined to fail. When the EuroZone economies take their next leg lower, led by their sovereign bonds, the Euro will fall hard. The fund has a reasonable expense ratio at 0.58%, especially considering an above average dividend yield of 2.56%.
The ProShares Investment Grade Hedged bond fund caps off the list. This alternative ETF provides investors exposure to investment grade corporate bonds while hedging exposure to rising interest rates by selling U.S. Treasury futures. The above average yield of investment grade corporates provides income for yield-starved investors while the loss of principal arising from rising interest rates is offset by the gains generated by the short position in the U.S. Treasuries. While credit risk will remain despite the hedge, interest rate movements have traditionally affected investment grade bonds more than credit concerns. The opposite is true for high yield bonds. This is why we favor IGHG instead of the high-yield equivalent product, HYG.
(You may also want to review our list of best inverse ETFs)