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Downside hedged ETFs

Introduction

Historically, stock market ETFs and stock market indexes generally remained invested in the stock market at all times. In the past few years, several ETFs have been developed based on indexes that attempt to dynamically exit the stock market when the stock market is in a down turn. We call these ETFs "downside hedged" ETFs.

The stock market crash in 2008 reminded everyone that stock markets are volatile, but most people also know that it is very difficult to "time the market". These downside hedged ETFs are tracking indexes that are using different strategies to determine when they are going to exit the market during the next down turn. Who knows what "secret sauce" will work?

Please note that many actively managed ETFs give their portfolio manager the freedom to make investment decisions, including whether to be invested in the market at all times. For purposes of this article about "downside hedged ETFs", we are focused solely on ETFs that track an index, even though many actively managed ETFs may also judgmentally try to downside hedge their portfolio.

Will it work?

Downside hedged ETFs did not exist in 2007 and 2008, when the last market crash occurred. So we have no real life experience with downside hedged ETFs.

Some of these downside hedged ETFs are using complex strategies to determine when to exit and re-enter the market. But you wonder whether a simple strategy would work. For example, S&P has an index called the S&P 500 Trend Allocator Index that selects the stocks from the S&P 500 Index, but exits the market if the last five consecutive closing levels of the S&P 500 Total Return Index are below the 200 day simple moving average on each of the five respective consecutive days. The index does not re-enter the market until there have been five consecutive days of the S&P 500 Total Return Index values being above the 200 day simple moving average.

The S&P 500 Trend Allocator Index has performed well, as it exited the market in 2008 to avoid the worst of the stock market crash. But the question is whether it will do well when the next crash occurs. The index was launched on November 2, 2015, so the performance shown in the graph above is all based on theoretical back-testing data. Who knows if S&P had the benefit of hindsight, and only came up with the formula for the index because they knew it would have worked during the 2008 crash? Who knows if the formula of exiting the market when the S&P 500 Index has been below its 200 day simple moving average for five consecutive days will work in the future?

That's the challenge with most of these downside hedged ETFs. They are using strategies and indexes that are mostly theoretical, and they are based on back-tested indexes. Who knows what will work during the next down turn?

These ETFs underperform during strong bull markets

Note that one drawback to these downside hedged ETFs and indexes is that during a strong bull market they may lag the market, because they may exit the market during a short-term dip in the market, when they really don't need to. The S&P Trend Allocator Index, for example, exited the market a couple of times during 2015 and early 2016, and by the time the index re-entered the market, the index was too late - the S&P 500 Index had already significantly rebounded. So dynamically exiting the market pays off when a crash occurs, but you pay for it during a strong bull market.

There are a number of downside hedged ETFs in our database:

Name	Symbol	Last price	Currency	Inception date
WBI BullBear Trend Switch 3000 Total Return	XNYS:WBIT	18.11	USD
Alpha Architect Value Momentum Trend ETF	XNAS:VMOT	34.46	USD	May 04, 2017
EquityCompass Risk Manager ETF	ARCX:ERM	23.09	USD
Pacer Trendpilot Fund of Funds ETF	ARCX:TRND	37.25	USD	May 06, 2019
Pacer WealthShield ETF	BATS:PWS	33.25	USD	Dec 12, 2017
VanEck Long/Flat Trend ETF	ARCX:LFEQ	61.21	USD	Oct 09, 2017
Invesco S&P 500 Downside Hedged ETF	XNYS:PHDG	37.80	USD	Dec 06, 2012
VictoryShares US EQ Income Enhanced Volatility Wtd ETF	XNAS:CDC	76.88	USD	Jul 02, 2014
VictoryShares US 500 Enhanced Volatility Wtd ETF	XNAS:CFO	82.16	USD	Jul 02, 2014
Innovator IBD 50 ETF	ARCX:FFTY	36.58	USD	Apr 09, 2015
Pacer Fund Trust Pacer Trendpilot US Large Cap ETF	BATS:PTLC	59.95	USD	Jun 12, 2015
Pacer Trendpilot US Mid Cap ETF	BATS:PTMC	41.05	USD	Jun 12, 2015
Pacer Trendpilot 100 ETF	XNAS:PTNQ	86.33	USD	Jun 12, 2015
Pacer TrendpilotTM European Index ETF	BATS:PTEU	34.29	USD	Dec 17, 2015
First Trust Dorsey Wright Dynamic Focus 5 ETF	XNAS:FVC	42.25	USD	Mar 18, 2016
AlphaClone Alternative Alpha ETF	XNYS:ALFA	62.10	USD	May 31, 2012
VictoryShares US Discovery Enhanced Volatility Wtd ETF	XNAS:CSF	51.03	USD	Aug 01, 2014
AdvisorShares Dorsey Wright FSM US Core ETF	XNAS:DWUS	59.78	USD	Dec 27, 2019
FIRST TRUST DORSEY WRIGHT PE	XNAS:DWPP		USD
Innovator IBD Breakout Opportunities ETF	ARCX:BOUT	44.16	USD	Sep 13, 2018
HCM Defender 500 Index ETF	ARCX:LGH	66.33	USD	Oct 10, 2019
HCM Defender 100 Index ETF	ARCX:QQH	84.02	USD	Oct 10, 2019
Schwab 1-5 Year Corporate Bond ETF	ARCX:SCHJ	24.50	USD	Oct 11, 2019
FORMULAFOLIOS SMART GROWTH	BATS:FFSG	28.43	USD
FORMULAFOLIOS TACTICAL INCOM	BATS:FFTI	20.03	USD
FORMULA FOLIOS HEDGED GROWTH	BATS:FFHG	32.23	USD
AdvisorShares Alpha DNA Equity Sentiment ETF	ARCX:SENT	21.22	USD
Corbett Road Tactical Opportunity ETF	ARCX:OPPX	22.33	USD
Exchange Listed Funds Trust Armor US Equity Index ETF	ARCX:ARMR	20.48	USD
Global X Adaptive U.S. Risk Management ETF	ARCX:ONOF	41.08	USD	Jan 12, 2021
Timothy Plan US Large/Mid Cap Core Enhanced ETF	ARCX:TPLE	27.74	USD	Jul 30, 2021
TrimTabs ETF Trust Donoghue Forlines Risk Managed Innovation ETF	BATS:ABOT	44.58	USD	Dec 08, 2020
TrimTabs ETF Trust Donoghue Forlines Tactical High Yield ETF	BATS:ABXB	19.16	USD	Dec 08, 2020