After staying pretty quiet through June, August and September, market volatility really picked up early this month, sending the Market Volatility Index (VIX) to its highest levels since February. The increase was not unexpected: several of our Digest contributors said an increase in volatility was their only sure market prediction going into the fall. John Buckingham, Editor of The Prudent Speculator, wrote: “We suspect that individual stock price volatility will pick up as we move into the heart of third-quarter earnings reporting season.”
While the market can still make significant gains during periods of higher-than-usual volatility, the choppy progress can be nerve-wracking for investors.
If you’re optimistic about stocks overall, but worried about the likelihood of higher volatility, there were two ETFs in the latest Investment Digest that might be of interest you.
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The first is the PowerShares S&P 500 Downside Hedged Portfolio (PHDG), which was recommended by Keith Richards in Investors Digest of Canada. He wrote:
“America is now in the throes of a long-term bull market, although the good times are not without their risks. ... I believe investors should now play the U.S. market to the upside, but hedge their bets by taking a more defensive position. [One way to do that is to use] funds that hedge their downside risk. For example, there’s the PowerShares S&P 500 Downside Hedged Portfolio (PHDG).
“As its name suggests, it holds the S&P 500. The twist is that this fund is based on the Veqtor Index. It’s a combination of the S&P 500 and the VIX, the Market Volatility Index of the Chicago Board Options Exchange.
“Effectively, this ETF remains fully invested in the S&P 500 until volatility, as measured by the VIX, starts to pick up. After that, the fund begins to leg into the VIX incrementally, offsetting some of the downside inherent in a falling market. The longer and bigger the selloff, the more exposed the fund becomes to the VIX and the less exposed it is to the S&P 500.”—Keith Richards, Investor’s Digest of Canada, October 2013
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A second, similar fund was recommended in the latest Investment Digest by Joseph Shaefer, Editor of Investor’s Edge. He wrote:
“Unlike short-only mutual funds or short ETFs such as the ones we currently hold, there are two relatively new exchange traded products (one three years old, the other out less than a year) which are based on the S&P 500 Dynamic Veqtor Index. This is one of the more interesting hedge alternatives I’ve seen in a long time. The index dynamically allocates between just three components: long-only (the S&P 500), the VIX Index (a short-term index of volatility) and cash. You’ll notice there is no ‘market short’ component here!
“Rather, the index uses volatility, via the VIX, as a proxy for a bad time to be in the market. There is a strong correlation between excessive volatility and a declining market. This index is designed to profit from that correlation, rather than using actual short positions. ... I like this approach. It provides market upside and protection against severe decline. ...
“The three-year-old is Barclays S&P 500 Dynamic Veqtor ETN (VQT). It has traded between 126 and 144 this year and is currently 139, up 7.8% for the year. As an ETN, it will normally use derivatives. ... I like their approach during a time to be cautious. We’ll buy a little.”—Joseph L. Shaefer, The Investor’s Edge, October 2013
Wishing you success in your investing and beyond,
Chloe Lutts Jensen
Editor of Investment of the Week
