Protecting Investors in a Bear Market: Hedged ETFs and Other Tools

In the current bear market, investors are seeking tools to protect themselves against and benefit from declines in stocks and bonds.

An EisnerAmper and Silley Circuits-hosted event titled “Protecting Investors in a Bear Market: Hedged ETFs and Other Tools” discussed how exchange-traded funds (“ETF”) can be utilized in the current market to generate positive returns while also guarding against market downturns. Panelists included:

• Yung Lim, CEO, FolioBeyond, manager of the RISR ETF, a fixed-income strategy which provides protection against rising interest rates; and
• Chris Rich, managing director, equity derivatives, StoneX Group, a brokerage firm which manages an equities strategy.

Panelists discussed these themes:

Fixed Income:

• The current market environment fosters a negative correlation between equities and bonds. Pre-2022 in a 60/40 portfolio when bonds went up, equities would sell off and vice versa; this changed last year because of inflation and rising interest rates. When rates went up, tech stocks were negatively impacted, raising concerns about Fed tightening, which led to equities and bond markets going up or down in tandem. Therefore, investors now need to find investments that add more diversification to their portfolio with uncorrelated risk-return profiles.
• Concerns about credit spreads widening in the current market. If the economy goes into a recession, floating rate credit sectors can present attractive income opportunities.
• Credit spreads are attractive, but they are contingent on the economic cycle. Investors should be mindful of taking on spread duration risk and stick to shorter duration bonds.
• The yield curve has been inverted for several months due to the risk of a recession and possible rate cuts and should normalize soon.
• Despite concerns about the debt ceiling, the issues will get resolved and might require more negotiations than in the past, given the divided U.S. Congress. However, for investors, this uncertainty isn’t beneficial since the downgrade of the U.S. Treasury in the past has caused forced selling.

Equities:

• With regards to volatility, the intraday volatility has come down after intraday swings of 3-5% over the last year or so. Volatility is expected to be determined by individual news events such as economic numbers like the Consumer Price Index (“CPI”) that are announced and statements from the Federal Reserve.
• Institutions are taking advantage of the volatility by purchasing short-day options, after historically being long-focused.
• Implied volatility and realized volatility have come down because markets when markets were going up following last year’s rise in volatility.
• In evaluating SPY options or QQQ options when it comes to hedging stock exposure, it makes sense to hedge portfolio exposure and buy put spreads; and if you have long stocks, to sell or overwrite calls.
• VIX used as a measure of volatility is a broken product because if investors buy a “cheap” product to drive their returns and it doesn’t perform as expected, then they are disappointed. Also because of the way the VIX is calculated, it doesn’t give weight to the short-dated options where a lot of the volume is.