Hedge Volatility With These Long/Short ETFs

Numbers on Monitor

After hitting a series of record highs, Wall Street was caught in selling pressure this week on inflation fears. This is especially true as both the Dow Jones and the S&P 500 posted their steepest three-day decline in nearly seven months, declining 3.4% and 4%, respectively. The tech-heavy Nasdaq Composite Index has lost 5.2% this week, representing its worst three days since early March.

Prices of consumer goods and services accelerated at their fastest pace since 2008 last month with the Consumer Price Index spiking 4.2% from a year ago and 0.8% from the prior month. This has flared up concerns that the central bank may tighten the policies earlier than expected though the Fed has signaled any rise in inflation as temporary (read: Inflation Is Picking Up: 5 ETFs to Make the Most of It).

However, the economy is showing speedy economic recovery backed by huge infrastructure and stimulus packages, widening reach of vaccinations and a healing job market. The combination has powered activities across all sectors and categories, resulting in increased consumer spending. Americans are spending on big-ticket items such as vacations and weddings, companies are going on hiring sprees, and the transition to new technologies such as electric vehicles is accelerating.

Consumer confidence has been on rise and the Conference Board consumer confidence index jumped to the highest level in April since February 2020. Retail sales also surged the most since May 2020 in March. Meanwhile, corporate results have turned out better than expected with all-around strength and momentum.

The U.S. economy grew 6.4% annually in the first quarter, representing the second-strongest increase since 2003 and is expected to top 7% this year, which would be the fastest since 1984, per several economists. This would follow the 3.5% contraction in 2020, which was the worst performance in 74 years (read: 5 Top-Ranked ETFs to Ride on a Booming Economy).

In such a scenario, investors continue to look for the best possible ways to protect their portfolio from the potential downside while still investing in growing equities. One such great strategy available in the space is long/short, which offers ways to seek profits and protection simultaneously.

What Are Long/Short ETFs?

The long/short ETFs take the best of each prediction by involving buying and short selling of equities at the same time. This strategy is primarily used by hedge funds and involves taking long positions (buy) in stocks that are expected to increase in value while short positions (short sell) in stocks that are expected to decrease in value.

This unique investment vehicle utilizes leverage, derivatives, futures or index options in order to maximize total returns irrespective of market conditions as well as hedge out the market risk in case of elevated risk. Despite the high level of due diligence, the strategy often comes with low fees, reduced risks and no lock-in period. These are extremely flexible and provide high levels of diversification benefits. The long/short strategy is highly uncorrelated to the traditional asset classes (see: all the Long/Short ETFs here).

The long/short include various types of strategies such as market neutral, hedging, option-writing, and 130/30 strategies (130% exposure to long positions and 30% exposure to short positions). While there are a number of ETFs in this space that could ride out ups and downs of the market scenario, we have highlighted five products from this space that could be compelling choices to play the current trends:

ProShares Large Cap Core Plus CSM

This fund tracks the Credit Suisse 130/30 Large Cap Index, which provides long/short positions in some of the largest 500 companies by applying a rules-based ranking and weighting methodology. It optimizes the portfolio, using the scores to overweight stocks with the most favorable outlooks and underweight or take short positions in stocks with less favorable prospects. CSM has AUM of $483.9 million and an expense ratio of 0.46%. It trades in volume of 15,000 shares a day on average.

First Trust Long/Short Equity ETF FTLS

This ETF is actively managed and intends to pursue its investment objective by establishing long and short positions in a portfolio of equity securities. The overall portfolio, under normal market conditions, will be 80 to 100% invested in long positions and 0% to 50% invested in short positions. The fund has amassed $353.1 million in its asset base while charges 1.55% in annual fees. It trades in an average daily volume of 25,000 shares.

AGFiQ US Market Neutral Anti-Beta Fund BTAL

The fund has the potential to generate positive returns regardless of the direction of the stock market as long as low-beta stocks outperform high-beta stocks. It invests in low-beta securities and at the same time shorts high-beta stocks of approximately equal dollar amounts within each sector. It seeks to deliver the spread return between low and high-beta stocks. This can easily be done by tracking Dow Jones U.S. Thematic Market Neutral Anti-Beta Index. The ETF has AUM of $98.6 million and an expense ratio of 2.19%. It trades in an average daily volume of 92,000 shares.

ProShares RAFI Long/Short RALS

This ETF seeks to isolate the potential for outperformance of the RAFI fundamental methodology by taking long positions in the RAFI US 1000 Index and short positions in the market-cap weighted Russell 1000 Index. It allocates equal dollar amounts to both long and short equity positions and follows the FTSE RAFI US 1000 Long/Short Total Return Index. The product has AUM of $4.7 million and charges 95 bps in annual fees. It trades in an average daily volume of 1,000 shares (read: 7 Inverse ETFs Riding High on Nasdaq Sell-Off).

LHA Market State Alpha Seeker ETF MSVX

This product uses an actively managed quantitative program to invest in the behavior of volatility. It employs a rules-based risk management approach to make tactical long/short allocations to equity futures & options, VIX futures & options, and ETFs utilizing a rules-based risk management approach. It has accumulated $22.6 million in its asset base since its inception and trades in an average daily volume of 4,000 shares a day. The ETF charges 1.50% in annual fees.

Bottom Line

Investors should note that these ETFs are less volatile, less risky and relatively stable when compared to the market-cap counterparts. In addition, these products provide hedging facilities that protect the portfolio from huge losses in turbulent times.

Disclosure: Zacks.com contains statements and statistics that have been obtained from sources believed to be reliable but are not guaranteed as to accuracy or completeness. References to any ...

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