With the S&P 500 up about 15% year-to-date, it would appear safe to say that the bull market is intact. The other side of that discussion is that stocks plunged in the fourth quarter, basically entering a bear market while reminding investors that equities do not move up in a straight line and carrying some downside protection is necessary.
While bull markets do not die of old age, there are signs this bull market is aging — something many investors have acknowledged for some time. With first-quarter earnings season right around the corner, investors may want to consider how companies report earnings as one sign of an aging bull market.
“S&P 500 companies reported about $1.37 trillion in adjusted earnings for 2018. They reported $1.17 trillion in GAAP earnings last year as well,” reports Barron’s. “(GAAP is short for ‘generally accepted accounting principles.’) In other words, the accountants signed off on $1.2 trillion in earnings. Management told investors they earned $1.37 trillion.”
Adding to the case for the best funds for downside protection are numerous factors, including flareups in the U.S./China spat, the fear of the Federal Reserve potentially reversing course and raising interest rates this year and the specter of markets pricing in concerns regarding 2020 presidential candidates.
For investors looking for downside protection, these are some of the best funds to consider.
Best Funds: Cambria Tail Risk ETF (TAIL)
Expense Ratio: 0.59% per year, or $59 on a $10,000 investment.
The Cambria Tail Risk ETF (CBOE:TAIL) is not just one of the best funds for portfolio protection, it is also one of the best to own when equities swoon. TAIL’s fourth-quarter chart proves as much.
The actively managed TAIL “offers the potential advantage of buying more puts when volatility is low and fewer puts when volatility is high,” according to Cambria. “While a portion of the fund’s assets will be invested in the basket of long put option premiums, the majority of fund assets will be invested in intermediate-term U.S. Treasuries. As the fund is designed to be a hedge against market declines and rising volatility, Cambria expects the fund to produce negative returns in the most years with rising markets or declining volatility.”
In other words, TAIL is one of the best funds when stocks are sinking, but when stocks are rising, TAIL is vulnerable, as highlighted by the fund’s year-to-date loss of almost 13%.
Invesco S&P 500 High Dividend Low Volatility ETF (SPHD)
Expense ratio: 0.3%
Low-volatility exchange-traded funds (ETFs) are often viewed as some of the best funds to consider when the market tumbles. The Invesco S&P 500 High Dividend Low Volatility ETF (NYSEARCA:SPHD) and rival “low vol” funds typically do not capture all of a bull market’s upside, but perform less poorly in a bear market.
If investors accept and understand that trait, SPHD can be one of the best funds if you’re seeking income and downside protection. SPHD, which pays a monthly dividend, has a 12-month distribution rate of 3.9%, about double the dividend yield on the S&P 500.
Historically, defensive sectors with high dividend yields trade at premium valuations, but that is not the case with SPHD. The fund devotes over 38% of its combined weight to the defensive real estate and utilities sectors, but more than 76% of its holdings are classified as value stocks.
ProShares Short QQQ (PSQ)
Expense Ratio: 0.95%
As the fourth quarter showed investors, when technology and other growth stocks fall out of favor, markets can rapidly deteriorate. One of the primary benefits of the tech-heavy Nasdaq-100 Index is that it overshoots more traditional broader equity benchmarks on the way up. However, with growth sectors, such as tech, communication services and consumer discretionary, commanding massive percentages of the overall U.S. equity market, declines in those groups usually permeate the entire market.
The ProShares Short QQQ (NYSEARCA:PSQ) is ideal for buffering against tech declines. Importantly, PSQ is one of the best funds for traders new to inverse ETFs, because this product is not leveraged. Rather, PSQ is designed to deliver the daily inverse performance of the Nasdaq-100. So if that index falls 1% on a particular day, PSQ should rise 1%.
Still, PSQ should be treated as a short-term instrument.
“Due to the compounding of daily returns, ProShares’ returns over periods other than one day will likely differ in amount and possibly direction from the target return for the same period,” according to ProShares.
AGFiQ US Market Neutral Anti-Beta Fund (BTAL)
Expense ratio: 0.76%
Like the aforementioned TAIL, the AGFiQ US Market Neutral Anti-Beta Fund (NYSEARCA:BTAL) is one of the best funds when stocks are declining. Buying this fund in advance of those declines can be risky because if stocks continue trending higher, BTAL likely generates negative returns.
“BTAL’s objective is to seek performance results that correspond to the price and yield performance, before fees and expenses, of the Dow Jones U.S. Thematic Market Neutral Anti-Beta Index,” according to the fund’s issuer. “BTAL strives to achieve this objective, by investing long in U.S. equities that have below average betas and shorting those securities that have above average betas, within sectors.”
BTAL is down 5% year-to-date, far better than the 13% loss sported by TAIL. In either case, investors are reminded these are among the best funds to own when equities are faltering. During lengthy moves to the upside, these products will lag.
Global X | JPMorgan U.S. Sector Rotator Index ETF (SCTO)
Expense Ratio: 0.83%
The Global X | JPMorgan U.S. Sector Rotator Index ETF (NYSEARCA:SCTO) is a small, overlooked ETF that employs a momentum-based U.S. sector rotation strategy. Despite its diminutive status, this could be one of the best funds to own when stocks sink because SCTO can move to 100% cash when volatility spikes or stocks decline.
“SCTO seeks to limit equity volatility to a maximum of 20% by allocating assets to short term treasuries in more unstable markets,” according to Global X.
This fund may be more appropriate for conservative investors because it does not need markets to fall in order to generate positive returns. That said, SCTO is positioned defensively with over 51% of its combined weight currently allocated to the Consumer Staples Select SPDR (NYSEARCA:XLP) and the SPDR Dow Jones REIT ETF (NYSEARCA:RWR).
As of this writing, Todd Shriber owned shares of SPHD.
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