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.

There are a number of downside hedged ETFs in our database:

CategoryCount
Asset Allocation4
Global Equity 4
US Equity25
US Fixed Income 2
Total35

Most downside hedged ETFs are relatively new:

Year of InceptionCount
20101
20123
20144
20155
20161
201713
20181
20196
20201
Total35

Note that there might have been even more ETFs launched then this table shows, as we are only displaying the launch dates of ETFs still active in our database. There might have been more ETFs that were launched during these years that have since been closed down by their sponsor.

Some of these downside hedged ETFs also combine downside hedging with other investment factors:

Number of Factors UsedCount
018
111
25
31
Total35

Here are the downside hedged ETFs, if you want to read some examples of the approaches taken by these ETFs:

SymbolDescriptionInception DateCategoryActions
VQTBarclays Dynamic VEQTOR ETN08/31/2010US EquityAnalyze
ALFAAlphaClone Alternative Alpha ETF05/31/2012US EquityAnalyze
DWPPFirst Trust Dorsey Wright Peoples Portfolio ETF08/29/2012US Equity Analyze
PHDGInvesco S&P 500 Downside Hedged ETF12/05/2012US EquityAnalyze
CDCVictoryShares US EQ Income Enhanced Volatility Wtd ETF07/01/2014US Equity Analyze
CFOVictoryShares US 500 Enhanced Volatility Wtd ETF07/01/2014US Equity Analyze
CSFVictory CEMP US Discovery Enhanced Volatility Weighted Index ETF08/01/2014US Equity Analyze
CIZVictory CEMP Developed Enhanced Volatility Weighted Index ETF09/30/2014Global Equity Analyze
FFTYInnovator IBD 50 ETF04/08/2015US EquityAnalyze
PTLCPacer Trendpilot 750 ETF06/12/2015US Equity Analyze
PTMCPacer Trendpilot 450 ETF06/12/2015US EquityAnalyze
PTNQPacer Trendpilot 100 ETF06/12/2015US Equity Analyze
PTEUPacer Trendpilot European Index ETF12/15/2015Global EquityAnalyze
FVCFirst Trust Dorsey Wright Dynamic Focus 5 ETF03/08/2016US EquityAnalyze
ERMEquityCompass Risk Manager ETF04/11/2017US EquityAnalyze
TERMEquityCompass Tactical Risk Manager ETF04/11/2017US EquityAnalyze
VMOTAlpha Architect Value Momentum Trend ETF05/03/2017Asset AllocationAnalyze
FFHGFormulaFolios Hedged Growth ETF06/11/2017Asset AllocationAnalyze
FFTIFormulaFolios Income ETF06/11/2017US Fixed Income Analyze
DMRIDeltaShares S&P International Managed Risk ETF07/31/2017Global EquityAnalyze
DMRLDeltaShares S&P 500 Managed Risk ETF07/31/2017US Equity Analyze
DMRMDeltaShares S&P 400 Managed Risk ETF07/31/2017US EquityAnalyze
DMRSDeltaShares S&P 600 Managed Risk ETF07/31/2017US EquityAnalyze
LFEQVanEck Vectors NDR CMG Long/Flat Allocation ETF10/04/2017US Equity Analyze
FFSGFormulaFolios Smart Growth ETF11/01/2017Asset AllocationAnalyze
PWSPacer WealthShield ETF12/14/2017US Equity Analyze
LDRSIBD ETF Leaders ETF12/21/2017Asset AllocationAnalyze
BOUTIBD Breakout Opportunities ETF09/13/2018US EquityAnalyze
TRNDPacer Trendpilot Fund of Funds ETF05/06/2019Global EquityAnalyze
WBITWBI BullBear Trend Switch US 3000 Total Return ETF05/29/2019US EquityAnalyze
LGHHCM Defender 500 Index ETF10/10/2019US Equity Analyze
QQHHCM Defender 100 Index ETF10/10/2019US Equity Analyze
SCHJSchwab 1-5 Year Corporate Bond ETF10/10/2019US Fixed Income Analyze
DWUSAdvisorShares Dorsey Wright FSM US Core ETF12/27/2019US Equity Analyze
ARMRArmor US Equity Index ETF02/11/2020US Equity Analyze

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.

Here is the performance of the S&P 500 Trend Allocator Index compared to SPY, an ETF which tracks the S&P 500 Index:


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?

Here are the downside hedged ETFs that we have given a rating of editor's choice, our highest rating:

SymbolDescriptionInception DateCategoryActions
DWPPFirst Trust Dorsey Wright Peoples Portfolio ETF08/29/2012US Equity Analyze
PTLCPacer Trendpilot 750 ETF06/12/2015US Equity Analyze
PTMCPacer Trendpilot 450 ETF06/12/2015US EquityAnalyze
PTNQPacer Trendpilot 100 ETF06/12/2015US Equity Analyze

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.


Similarly, PTLC, the Pacer TrendPilot 750 ETF, which we have rated an "editor's choice", has also significantly underperformed SPY since inception, because it has also incorrectly exited the market when it didn't need to:


But owning PTLC will hopefully pay off when the next big crash happens. Here is the theoretical back-test data for PTLC's index:



All data is a live query from our database. The wording was last updated: 10/27/2018.

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