Exchange traded funds offer investors the opportunity to diversify and hedge against market volatility with varying asset classes or even allow investors to hedge against volatility directly.
For instance, the First Trust CBOE S&P 500 VIX Tail Hedge ETF (VIXH) began trading a few months back and PowerShares S&P 500 Downside Hedged ETF (NYSEArca; PHDG) was launched early December. Both new funds utilize the CBOE Volatility Index, or VIX, to mitigate large market drops. [PowerShares Readies ‘Downside Hedged’ ETF]
However, there are some difference. VIXH continuously maintains a 1% position in VIX front-month calls, whereas PHDG is an actively managed ETF that uses equities, cash and VIX futures, writes Roger Nusbaum for TheStreet.
Specifically, PHDG holds a default cash weighting of 0% or 100% – if the market is down 2% in the last five days, the ETF will hold cash. On the VIX side, the ETF allocates based on varying volatility ranges, which cover 0-10%, 10-20%, 30-45% and 45-60%, and then further broken down to three possible VIX futures positions based on rising, flat or declining volatility.
The VIXH ETF will hold its 1% allocation to VIX options, so any potential performance drag as associated with expiration on the options will be anticipated. [Fear Factor: An ETF to Hedge ‘Black Swan’ Events]
For either ETFs, investors should know that both funds would underperform in bull market rallies, but the extent to which PHDG will underperform is less predictable because of its active allocation strategy.
For more information on the VIX, visit our VIX category.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.