This article was originally published on ETFTrends.com.
Given the current certainties and market risks, ETF investors should construct resilient portfolios to participate on any further upside and hedge the downside.
On the recent webcast (available On Demand for CE Credit), Potential ETF Strategies for Today’s (and Tomorrow’s) Markets, Sylvia Jablonski, Managing Director and Institutional ETF Strategist for Direxion and Portfolio+ ETFs, outlined a number of global elements that may influence an investor portfolio, such as the U.S. economy entering late-cycle phase, the Federal reserve moving toward monetary policy normalization, rising interest rates, building inflationary pressures, increasing dispersion amongst sectors, and changing geopolitical climate.
"If you’re an investor, you have to believe that markets generally rise over time. But of course there are from time to time, periods of high volatility. They’re relatively infrequent and short-lived," Jablonski said.
Investors will no longer experience the smooth sailing of yesteryear. John Davi, Founder and Chief Investment Officer of Astoria Portfolio Advisors, pointed out that Astoria has already implemented hedges to limit potential swings in risk assets as the year progresses.
"Without question, the easy money has been made in this cycle. Astoria hedges risk assets and increased our hedges as the year progressed," Davi said.
"We see a lot of recession checklists being produced," he added.
How to Limit Potential Risks in Overheating Economy
Consequently, Astoria has been advocating hedging and liquid alts in a diversified portfolio as a way to limit the potential risks that the economy is overheating, especially after measures like an enormous tax cut and fiscal stimulus in the late stages of an economic cycle.
"Trump’s boom or bust presidential style volatility needs to be modeled and accounted for. If anything, Trump pulls recession risks forward," Davi said.
Jablonski explained that many typically see themselves as a strategic, long-term investor, but there may be opportunity in intermediate-term, slower moving investment themes over the mid- and short-term. Consequently, she explained that ETF investors may consider solutions, depending on their situation.
For example, investors can look to a relatively new family of ETFs, called Portfolio+ ETFs, which can potentially enhance a bullish stance by providing 25% added daily exposure to popular broad-based indexes targeted by advisors. The ETFs include the Portfolio+ S&P Mid Cap ETF (PPMC) , Portfolio+ Developed Markets ETF (PPDM) , Portfolio+ Emerging Markets ETF (PPEM) , Portfolio+ Total Bond Market ETF (PPTB) , Portfolio+ S&P 500 ETF (PPLC) and Portfolio+ S&P Small Cap ETF (PPSC) . The Portfolio+ ETF seek 125% of the daily performance of their benchmark indices, which may help provide magnified returns in order to generate outperformance over time.
Jablonski argued that advisors can also look at leveraged and inverse ETFs to hedge rising risks in an extended bull market.
Leveraged and inverse ETFs “allow investors to gain exposure without the need for full dollar-for-dollar investment,” Jablonski said.
Investors should also keep in mind that most leveraged ETFs are designed to produce double or triple the performance of the underlying market on a daily basis. Consequently, when investors look at the long-term performance of a typical leveraged ETF, people may notice that the fund may not perfectly reflect their intended strategies.
A market without long interruptions and relative lack of volatility will help maintain positive gains in a leveraged ETF. Since the ETFs rebalance on a daily basis, compounding effects benefit leveraged ETFs in a consistently trending market. On the other hand, in times of increased volatility, leveraged ETF returns can fall behind their intended 2x or 3x strategies.
Potential leveraged and inverse ETF traders should closely monitor their positions. During highly volatile periods for a fund’s benchmark index, you will need to adjust your positions frequently to maintain constant exposure levels. During periods of lower volatility for the benchmark index, you should continue to monitor, but position adjustments will likely be needed less frequently.
The Direxion Daily Energy Bull 3X Shares (ERX) , which tracks the 300% daily performance of the Energy Select Sector Index, and Direxion Daily Energy Bear 3X Shares (ERY) , which reflects -300% daily performance of the energy select sector index, can help traders gain exposure to the swings in the crude oil industry after oil prices plunged and seek to consolidate in light of ongoing concerns over a global supply glut.
The technology sector has been among the best performing areas of the market as growth- and momentum-driven stocks lead. However, as we recently witnessed, the Direxion Daily Technology Bear 3X Shares (TECS) and Direxion Daily Technology Bull 3X Shares (TECL) could help traders ride the twists and turns in the technology sector.
Jablonski also pointed to leveraged and inverse Treasury ETFs, like the Direxion Daily 20+ Year Treasury Bull 3x Shares ETF (TMF) and Direxion Daily 20+ Year Treasury Bear 3x Shares ETF (TMV) , for short-term and long-term hedging with changes in the fixed-income landscape. For instance, a 1% rise in interest rates would be more detrimental to longer duration bond positions, so investors may implement an inverse hedge for a rising rate environment.
Financial advisors who are interested in learning more about investment strategies for today’s markets can watch the webcast here on demand.
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