Best Inverse ETFs to Hedge Your Portfolio

1- SH

The Standard & Poor’s 500 Inverse ETF, SH, should be considered for any hedged portfolio. It aims to deliver the opposite return of the S&P 500 on a daily basis. By bench marking this broad index, many of the ‘Most Widely Held’ stocks within investors portfolios will be included. The vast majority of stocks move in tandem with the broader market so it acts as a pretty good hedge of a broad equity portfolio. Also, since roughly 40% of S&P company’s profits come from overseas, you’ll also be partially hedging a slowdown in developed international markets. SH has one of the lowest expense ratio (0.90%), highest 90-day average volume (7.8 million shares) and most net assets ($2.7 billion) on our best inverse ETFs list, via data from Fidelity. If you want to protect your portfolio against a bear market in large cap U.S. stocks, consider SH.

2- PSQ

Given the unprecedented move in the NASDAQ, coupled with the narrowness of the advance, investors may want to seek out some inverse technology ETFs for hedging. It is amazing that the NASDAQ has returned to it old year 2000 highs, with shakier overall financial conditions as a backdrop. No major index has rebounded as strongly off the financial crisis lows of March 2009. Of course, the NASDAQ 100 has a history of sharp, sustained sell-offs, which is when inverse ETFs track their benchmark the best (outside of daily moves).

The NASDAQ 100, a market cap weighted index, is being disproportionately moved by the popular big name stocks of today. The so-called FAANG stocks, Facebook, Apple, Amazon, Netflix and Google, account for around one-third of the weighting in the NASDAQ 100 and the Top Ten Holdings in the QQQ comprise over 50% of the fund, according to Morningstar. This is not the sign of a healthy market. If you own the QQQ or any of these names and fear your portfolio may be over-concentrated, the ‘Short QQQ’ may be a way to mitigate some of the market risks associated. PSQ enjoys a miniscule 0.05% tracking error and remains a staple on our best inverse ETFs list.*

3- SJB

The high yield sector got so overbought that it was yielding just above 5% a couple years ago. This was actually lower than our risk-free rate before  (as measured by the Federal Funds rate). Since the risk for junk bonds is so profound, the underlying benchmark could lose almost all of its value. The liquidity is very poor for the trading of these securities given the lower inventories dealers are required to maintain due to regulations such as Dodd-Frank. According to a Bloomberg Gadfly story, 40% of the $1.4 trillion of junk bond debt did not trade at all during the first two months of 2016. When sellers come in, expect ETFs like JNK and HYG to be gapping lower (similar to what was seen in August of 2015) which could provide a commensurate boost to SJB. The only downside is RWM’s tracking error of 0.42, which speaks to the illiquidity of the underlying benchmark.

4- RWM

Small-cap stocks are especially dangerous. The Russell 2000 is extremely over-extended, reaching a high of 1296 in 2015, a level twice as high as at the dotcom peak in early 2000. These companies are especially vulnerable to deflation and will likely be the first to have access to credit denied. Getting out of small-cap stocks will probably exacerbate downside price moves due to illiquidity and low trading volumes. The Russell 2000 has soared over 18.5% from the February 11th, 2015 low into April, filling some key gaps. The sharpness of this bounce has bear market rally written all over it.

5- FAZ

While triple leveraged inverse ETFs are only for aggressive investors, we had to include at least one on the list. Financial stocks have the potential to get hurt badly as the next wave of the bear market ensues. Stock values for this sector have grossly under-performed, indicating relative weakness, and are still well below their financial crisis peaks. Balance sheet implosions are likely to become more mainstream. Conventional wisdom suggests that rising interest rates will buoy these stocks as their net interest margins, and thus profitability, will increase. While this may be true, many of the stocks in this index have much bigger problems coming from rising rates. Insurance stocks are giant junk-bond portfolios which could get crushed if rates rise. Also, rising rates will slow down the corporate borrowing and M&A binge that has pumped up investment banking profits. Some of the institutions in this index are designated SIFIs and thus will be forced to maintain high levels of Tier One capital which will probably come from dilutive equity follow-on offerings.

 

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