Complacency in the stock market is almost palpable as $300 billion has flowed into ETF coffers since the U.S. presidential election just seven months ago. With domestic and international indices hitting new all-time or 52-week highs, there continues to be a pervasive sense of calm in stock markets around the globe.
While many investors may be ignoring the risks of a pullback, there are some select ETF issuers who are thinking of the bigger picture and delivering tools to ride out future storms. Three fund companies have released diversified equity strategies this year with built-in hedges or risk management measures to reduce downside volatility. These risk-aware funds will provide active investors greater options to consider if capital preservation or minimizing volatility is a top priority.
One of the more successful ETF launches this year has been driven by the quantitative strategies of Quant X Funds. Their Quant X Risk Managed Growth ETF (QXGG) has accumulated $84 million since its January debut in pursuit of a dynamic offensive/defensive solution to the markets.
This “fund of funds” style ETF replicates an index that is primarily invested in U.S. and international stocks with the capability to shift towards cash and fixed-income as a defensive hedge. The model is driven by a rules-based methodology to exploit upside potential in the markets with an eye towards capital preservation if conditions deteriorate.
As of the end of April, 75% of the QXGG portfolio was allocated to stocks, with 25% in cash and bonds. These ratios shift over time as market factors move through varying cycles. The total expense ratio of QXGG is 1.22%, which includes acquired fund fees as well.
It’s interesting to note that the majority of the QXGG U.S. equity allocation is centered in their own Quant XDynamic Beta US Equity ETF (XUSA), which uses factor-based screening to select a small group of domestic stocks. This arrangement is commonplace for fund companies to use their own suite of ETFs to comprise other more diversified indexes.
Two other ETFs in the risk on/off category are the EquityCompass Risk Manager ETF (ERM) and EquityCompass Tactical Risk Manager ETF (TERM). These actively managed funds are distributed through the First Trust platform and are sub-advised by EquityCompass Strategies.
ERM provides direct exposure to about 150 U.S. stocks as the core of its portfolio strategy. During periods that the portfolio manager deems as unfavorable, they can shift a portion of the holdings into cash or short-term fixed-income positions. The amount and timing of these changes is completely at the discretion of the management team.
Similarly, TERM follows the same overall guidelines with the caveat that this fund can add a significant portion of the portfolio to short positions in the broad equity indices. The tactical designation is a more aggressive way to get defensive, which can also establish differing risk dynamics as well. Any hedges maintained by TERM will work as a drag against the long portions of the portfolio in an uptrend. Both funds charge a net expense ratio of 0.65%.
Lastly, it’s notable that Cambria Investment Management recently released the active Cambria Core Equity ETF (CCOR) for defensive-minded investors. Under normal conditions, this fund invests 80% or more of its portfolio in U.S. equity securities and uses options to control volatility. The objective is long-term capital appreciation, while reducing risk exposure across varying market cycles.
This ETF stands apart from the others in the group because of its use of options trading strategies. CCOR will also benefit from the quantitative security selection that Cambria is best known for. This fund charges an expense ratio of 1.05% and is the newest among this peer group.
The Bottom Line
Controlling risk is often a top priority for conservative investors or those with absolute return objective. The funds listed above all benefit from the liquid and diversified nature of the ETF vehicle, alongside the capability to size down their exposure to the stock market as needed.
The true test will be monitoring how these funds perform during a correction or prolonged bear market to determine the efficacy of each strategy. It’s likely that in the next few years, these funds will get to prove their worth and will attract greater attention as a result.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.