Two months ago, I noted that ValuEngine models were predicting a down market for 2022 and wrote a column on redeployment of core assets for investors with short-to-medium equity time horizons. The question for investors concerned with a downturn is what to do and if reallocation from assets committed to core equity is required, how much should be reallocated and where should these assets go? 

It turned out to be quite timely as the Year-to-Date (“YTD”) S&P 500 ETF SPY is down more than 7.8%. I recommended that concerned investors consider moving about 30% of their current core equity exposure to less volatile options. This should allow them to better weather a potential storm without bailing out altogether. 

This was a troubling risk-on environment spurred on by macroeconomic dynamics before Russia invaded Ukraine. Now we have a full-on Black Swan Environment. So how did our list of more defensive equity options hold up and where should investors consider putting money now?

In the aforementioned article, we examined a number of ETFs engineered to participate at less than 100% when SPY is performing well but has less participation when SPY rises. Now, we’ve added five other ETFs that fit the category to the list. 

Two months later, let’s see how they’ve fared in this year’s significant YTD downturn as of market close on March 4, 2022. 

The list included:

SPLV, the Invesco S&P 500 Low Volatility ETF. It selects about 100 S&P 500 stocks with the lowest daily volatility over the twelve months

USMV, the iShares MSCI USA Min Vol Factor ETF. USMV is optimized to minimize overall portfolio price volatility while keeping other factor exposures similar to the S&P 500 Index.It follows a complex factor optimization approach to reconstitute and rebalance portfolios.

DIVZ, the TrueShares Low Volatility Equity Income ETF, holds an actively managed, concentrated portfolio of US-listed companies that are favorably valued and have attractive dividends. The fund also seeks to deliver lower volatility than the overall market. The fund adviser initially screens US-listed securities for sustainable dividend growth using various quantitative and qualitative indicators. Then high-quality companies are identified based on high cash flow, stable revenue streams and capital reinvestment programs. This process is expected to deliver lower volatility than the overall US equity market. Finally, the fund adviser selects securities trading at attractive valuations. The actively-managed fund’s methodology results in a narrow selection of 25-35 stocks. TrueShares is the ETF brand of hedge fund True

XLU, the Select Sector SPDR Utilities ETF was the first Utilities ETF. It is comprised of all the utilities in the benchmark index. The chart below illustrates that for 21 years, XLU has generally, but not always, risen about half as much as SPY in strong years for the benchmark index and fallen about half as much when the S&P 500 fell. Its Beta of 0.47% reflects exactly that.

UTES, the Virtus Reaves Utilities ETF, is an actively managed ETF that focuses on the stocks of utility companies. Active exposure is rare among sector funds, especially with respect to utilities. Managed by Reaves Asset Management, the fund uses fundamental, growth, and risk-based metrics such as capital structure, historical earnings growth, and share price volatility.

The following ETFs are partially derivative-based and do not have ValuEngine reports available. All of them were engineered to mitigate losses in equity market downturns. Among these six, only SWAN was analyzed in the January blog article.

SWAN, the Amplify Black Swan ETF, SWAN, is designed to participate in 30% of S&P 500 returns by holding laddered 10-Year Treasury Bonds and using the income to purchase long-dated call options on the S&P 500.

BJAN, Innovator U.S. Equity Buffer ETF, uses options in an effort to moderate losses on the S&P 500 over a one-year period starting each January. The fund foregoes some upside return as well as the S&P 500’s dividend component because the options are written on the price (not total) return version of the index. In exchange for preventing realization of the first 9% of the S&P 500’s losses, investors forego upside participation above a certain threshold, which is reset annually. Investors who buy at any other time than the annual reset day may have a very different protection and buffer zone. The issuer publishes effective interim levels daily on its website.The fund must be held to the end of the period to achieve the intended results. The targeted buffers and caps do not include the fund’s expense ratio. The fund is actively managed, resets annually, and uses listed options exclusively. Innovator has 11 clone funds: BFEB, BMAR, BAPR, etc. to accommodate investors who want to invest on the first day of other months and wish to lock in the same kind of protection.

SPD, the Simplify US Equity PLUS Downside Convexity ETF owns S&P 500 ETFs but can have up to 20% of its portfolio in put options as warranted by market conditions according to its decision rules.SPD aims to deliver simple convexity without the complexity of buffered ETFs.

ASPY, ASYMShares Asymmetric S&P 500 ETF is an indexed and rules-based alternative strategy to hedging US large-cap equities. The fund targets between -25% and 75% net long equity exposure based on market risk. The strategy aims to provide protection against bear market losses, by being net short, and to capture the majority of bull market gains, by being net long, with respect to exposure to the S&P 500® Index. The strategy is powered by ASYMmetric Risk Management Technology™, intellectual property that uses price-based algorithms to identify “risk-off”,” risk-elevated.”

QAI, IQ Hedge Multi-Strategy Tracker ETF, seeks investment results that track, before fees and expenses, the price and yield performance of the IQ Hedge Multi-Strategy Index. The IQ Hedge Multi-Strategy Index attempts to replicate the risk-adjusted return characteristics of hedge funds using multiple hedge fund investment styles, including long/short equity, global macro, market neutral, event-driven, fixed-income arbitrage, and emerging markets. IQ is managed by New York Life Investment Management, owner of the Index IQ brand.

RPAR, the Risk Parity ETF is actively managed yet nonetheless aims to align its exposure to an index, the Advanced Research Risk Parity Index. The index diversifies across four asset classes (TIPS, US Treasury Bonds, global equities and commodities), seeking returns similar to global equities with less risk over time. It is sponsored by LA-based hedge fund provider Evoke Aris.

The table below lists data in pertinent categories for all 11 ETFs explained above as well as two benchmarks, SPY, the original SPDR owning the S&P 500 Index portfolio is a standard equity benchmark ETF.We also include AGG, the iShares Core Aggregate Bond ETF, the oldest bond ETF, because many of the derivatives-based ETFs benchmark themselves against the traditional 60/40 stocks-to-bond ratio portfolio.SPY and AGG are considered the standards by most professionals because they have the most Assets Under Management and the deepest liquidity.

Key Findings:

1. All 11 ETFs, the five that contain volatility through equity selection without derivatives and the six that employ derivatives to varying extents, delivered in terms of the two risk measures. They all posted betas and standard deviations lower than the S&P 500.  This is in line with the expectations that their websites try to convey to investors. The lowest beta and standard deviation overall belong to market-neutral QAI.

2.  The 5 stock ETFs all outperformed SPY for the past 12 months while the 5 derivative-based and risk-managed ETFs with at least 12 months of history produced less than 50% of the price return of the S&P 500. Of the latter group, only RPAR had a higher dividend yield.  During the YTD downturn, only DIVZ delivered positive performance.SWAN and QAI particularly disappointed their investors.SWAN contains Black Swan in its name, but the current Russian-invasion-influenced downturn is most certainly a Black Swan event and the runaway inflation may qualify in most minds as well after 40 years of manageable price inflation. The bottom line is that SWAN did not hold up in the Black Swan political and macroeconomic environments.QAI delivered on its relative market neutrality in the YTD time frame but its very disappointing 12-month performance, negative in a positive market, and underperforming even the negative performance of AGG was not what investors expected from this ETF. USMV also disappointed YTD with a performance even more negative than that of SPY but made up for that somewhat with a market beating performance over 12 months.

3. The two actively managed ETFs, DIVZ and UTES were the best performers on a combined time frame basis relative to SPY.DIVZ was spectacular in the downturn posting a 4% positive return in the negative market, one of the top 5 non-leveraged ETFs covered by ETF.com.Its 390 (18.7% - 14.9%) relative to SPY for the 12-month period was second only to UTES among our group of ETFs.As a bonus, the dividend yield DIVZ of 3.7% was close to twice of the 2.0% yield of AGG and three times the 1.3% yield available from the S&P 500. Given that UTES operates in the utility sector, income investors will be disappointed to learn that its yield is a paltry 0.9% and may prefer XLU with a 2.8% yield, comparable performance numbers, and a much lower expense ratio. 

4. SPLV, INVESCO Low Volatility S&P 500 ETF performed better than expectations and the other low-vol indexed ETF, USMV.It delivered better than index performance in both the “black swan” period in which we are still immersed and during the past 12 months as well. 

5. ValuEngine’s ratings for the next 12 months expect underperformance for the four low-vol equity and utility sector ETFs that held up well and expects only USMV to perform in line with SPY.  

6. The derivative-based ETFs engineered to preserve capital during downturns while participating significantly in upturns did not achieve these objective as well as the low-vol and utility sector equity ETFs.Simplify’s SPD put strategy saved just an 0.2% return differential vs. SPY YTD but easily registered the best performance of these ETFs during the past 12 months. SPD returned 11.7%, not as strong as SPY but nearly double second-place finisher RPAR. As a quant, the ASPY strategy is very intriguing but since the ETF is less than twelve months old, we’ll need more data before we can evaluate it. 

7. RPAR outperformed BJAN in both YTD and in the twelve-month period on a price basis. The difference is greater on a total return basis since BJAN has a zero-dividend yield in contrast to 2.1% for BJAN. Since the ETFs have similar objectives and RPAR has lower fees and what I find to be a more comprehensive risk management methodology, I personally find RPAR more attractive than BJAN.

In summary, the nature of Black Swan events is such that I would not extrapolate too much from these comparisons. Again, I’m not certain whether the inflation spike with related macroeconomic implications qualifies as a Black Swan event.I have no doubts that the Russian Invasion and the accompanying oil price shocks definitely qualify. In such an environment, all 11 of these ETFs are worthy of research.  Most of these are solid and well-constructed products for deployment in risk-on and risk-alert environments. The fact that both actively managed ETFs held up so well provides more evidence for the belief that while a cap-weighted index core holding is best in risk-on environments, active management and active asset allocation are better suited to hold up in significant downturns. In conclusion, there are some good reasons to consider diverting 20% - 30% of core index fund money to vehicles that put safety over price gains. My personal choices now would include RPAR, DIVZ, XLU, UTES and QAI.

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