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All Contents © 2017The Kiplinger Washington Editors
By Kyle Woodley, Senior Investing Editor
| September 27, 2017
Famed investor and Quantum Fund co-founder Jim Rogers made waves recently when he warned of a new bear market – “horrendous, the worst,” he said – brought on by global debt that has piled too high. But he had a specific warning for owners of exchange-traded funds:
“When we have the bear market, a lot of people are going to find that, ‘Oh my God, I own an ETF, and they collapsed. It went down more than anything else.’ And the reason it will go down more than anything else is because that’s what everybody owns.”
“Everybody” might be a stretch, but not a long one.
While still miles away from the $17.7 trillion in U.S. mutual funds, U.S. ETFs and other exchange-traded products have gobbled up $3.1 trillion. And more than 14% of that is tied up in just three funds – the SPDR S&P 500 ETF (SPY), iShares Core S&P 500 ETF (IVV) and Vanguard S&P 500 ETF (VOO) – that provide basic market exposure by tracking Standard & Poor’s 500-stock index. In other words, hundreds of billions of ETF dollars are being devoted to just 500 stocks.
It stands to reason, then, that if the market plunges, all of those investors who have tried to improve their odds by eschewing stock picking and relying on broad-market ETFs will still be at significant risk. But a few funds can help you minimize the damage.
Here are five “crash-proof” ETFs that offer ways to protect against (or even profit during) a bear market.
Data is as of Sept. 25, 2017. Click on symbol links in each slide for current share prices and more. Yields represent the trailing 12-month yield, which is a standard measure for equity funds.
Share price: $54.31
Market value: $9 billion
Year-to-date return: 4.6%
Dividend yield: 2.6%
Expenses: 0.14%, or $14 annually on a $10,000 investment
Wall Street tends to duck for cover in so-called “safe haven” sectors – think utilities, which traditionally have high dividends and whose services are in demand in good times and bad – when investors' confidence in the markets is shot.
But consumer staples might be an even better protective play than utilities.
Consumer staples are the essentials that humans need day in and day out. During economic downturns, Americans can temporarily stop going out to restaurants or spending on gadgets, but they can’t abandon basics such as bread, milk, toilet paper and, for some, tobacco. This means fairly reliable revenues and consistent cash flows for consumer-staples companies that help fund decent dividends.
The Consumer Staples Select Sector SPDR Fund currently invests in 34 such stocks. And because XLP is a market-capitalization-weighted fund – where larger companies comprise more of the ETF’s assets under management – it’s top-heavy, with Procter & Gamble (PG), Philip Morris International (PM) and Coca-Cola (KO) combining to take up roughly a third of assets. XLP invests not just in producers, but retailers – mostly grocers such as Kroger (KR), and pharmacy chains such as Walgreens Boots Alliance (WBA) and CVS Health (CVS).
XLP also boasts a yield of 2.6% that’s far better than most of the other SPDR sector funds, reflecting the income-heavy nature of consumer staples.
This ETF’s resilience was on display during the bear market of 2007-09, when the XLP produced a total return of -28.5% – far better than the -55.2% from the S&P 500 and the -42.5% from safe-haven peer Utilities Select Sector SPDR Fund (XLU). And in rough waters such as 2015, when the S&P 500 returned just 1.3% on a total basis, XLP delivered nearly 7% with dividends included.
Not bad for toilet paper and toothpaste.
Share price: $41.09
Market value: $2.9 billion
Year-to-date return: 3.8%
Dividend yield: 3.7%
Low-volatility funds are designed to keep investors exposed to stock-market upside while reducing risk. They may underperform during ranging bull markets, but they are built in such a way that they should outperform when the bears take control.
But low-vol ETFs come up short in one area: yield.
One might assume a low-volatility strategy would include a bundle of blue chips with big dividends. In reality, that’s not always the case. In fact, low-vol ETFs can be downright chintzy, with most sporting yields around 2.5% or less. That’s why the PowerShares S&P 500 High Dividend Low Volatility Portfolio and its 3.7% yield stick out in this category.
SPHD develops its portfolio by identifying the 75 highest-yielding securities in the S&P 500 over the past 12 months, with a cap of 10 stocks from any one sector. From there, it picks the 50 stocks that have exhibited the lowest volatility from the past 12 months. Holdings are then weighted by dividend yield.
At the moment, the portfolio is dominated by real estate (23.6%), utilities (18.8%) and consumer staples (10.9%) – all fertile grounds for high dividends. However, single-stock risk is minimal, with top holding Iron Mountain (IRM) accounting for a mere 3.4% of SPHD’s assets. That means a single company’s implosion won’t send the ETF collapsing with it.
SPHD is a relatively young fund that came to life in October 2012, so it hasn’t tested its mettle against the likes of the 2007-09 bear market. But it had an encouraging 2015 in which it beat the S&P 500 by nearly 4 percentage points, and boasts roughly the same advantage over the trailing three-year period. That provides confidence that SPHD should show some grit in any muddy waters that lie ahead.
Share price: $84.49
Market value: $11.2 billion
Year-to-date return: 0.1%
Dividend yield: 1.2%*
While XLP and SPHD are more focused on limiting bear-market downside while providing some bull-market upside, the iShares 1-3 Year Treasury Bond ETF is a much purer crash-proof ETF.
The SHY isn’t an exciting fund. It’s a simple index ETF that invests in a basket of 65 short-term U.S. Treasuries with an average effective maturity (the amount of time until a bond’s principal is paid in full) of just less than two years. It’s an incredibly safe fund given the security of Treasuries – two of the three major credit providers give American debt the highest possible rating – and the short maturity, which tamps down on the risk of interest rates rising quickly and making the fund’s current holdings less attractive.
The downside? The U.S. doesn’t have to offer much yield on these bonds to generate interest, and as such, the SHY only yields 1.2%. Moreover, the prices of these bonds barely budge. In the past five years, the SHY has traded in a tight range of less than 2% from peak to trough. So in good times, the S&P 500 crushes short-term bonds. The stock index has an average annual total return of 13.6% over the past five years, versus a mere 0.5% a year for the SHY.
But that same lack of movement starts to look awfully attractive when you’re staring a bear market in the face.
Investors tend to put money into short-term bond funds like SHY when they’re either unsure about the market or sure that stocks are about to tank. Yes, they could go completely to cash, but with SHY, they can at least put their money to work making a tiny bit of interest.
To see how effective SHY can be, look no further than the 2007-09 bear market, during which the SHY doled out a total return of positive 11%.
* The yield for this ETF represents the so-called SEC Yield, which reflects the interest earned for the most recent 30-day period after deducting fund expenses. SEC Yield is a standard measure for bond funds.
iShares Gold Trust
Share price: $12.60
Market value: $9.2 billion
Year-to-date return: 12.9%
Dividend yield: N/A
Gold is another popular flight-to-safety play, mostly based on worst-case-scenario fears. The broad idea is that if global economic structures come crashing down and paper money eventually means nothing, humans still will assign some worth to the shiny yellow element that once acted as a currency … even if it doesn’t have as much practical use as other metals and goods.
How true that is has yet to be determined. Plus, several studies have shown that gold, which doesn’t generate earnings or distribute cash to shareholders, can’t hold a candle to stocks and bonds as a long-term investment. Investors also need to know that gold can be influenced by other factors, such as jewelry demand and the strength of the U.S. dollar, which gold and other commodities are priced in.
Nonetheless, investors have flocked to gold in previous periods of stock-market turbulence – most notably in the wakes of the turn-of-the-century dot-com crash and the 2007-09 crash – and may provide similar protection in another ugly downturn.
ETFs such as the iShares Gold Trust provide exposure to gold without the hassles of owning the physical metal – namely, taking delivery, storing it, insuring it and unloading it on someone else when you’re done with it. Specifically, the IAU issues shares that represent gold held in physical vaults, and each share trades at roughly 1/100th the price of an ounce of gold.
The IAU is actually the second most popular physical gold ETF, at just $9 billion in assets versus $36 billion for the SPDR Gold Trust (GLD). However, GLD’s popularity comes from institutional investors. Each unit is worth roughly 1/10th an ounce of gold, meaning high-volume traders can save on per-share fees for the same amount of gold.
But IAU is the better deal for regular investors thanks to its far cheaper expense ratio (0.25% versus 0.4% for GLD).
Share price: $32.44
Market value: $1.8 billion
Year-to-date return: -10.6%
The ProShares Short S&P500 ETF is perhaps the ultimate crash-proof ETF in the sense that it’s quite literally designed to profit from a market crash. However, buy-and-hold investors should tread carefully.
The SH uses a complex system of swaps and other derivatives (financial instruments that reflect the value of underlying assets) to produce a very simple result: the inverse return of the S&P 500 index. In short, if the S&P 500 loses 1%, the SH should gain 1%, before fees and expenses. And if you look at any chart showing both this ProShares ETF and the S&P 500, you’ll see that the two are virtually mirror images of one another.
You could empty all your long positions in anticipation of a market crash that may or may not come, but doing so racks up trading fees and could wipe out favorable dividend yields in positions you established at much cheaper prices. Besides, we don’t recommend wholesale timing of the market. Instead, you can buy the SH as a small hedge against your long positions, so if they do fall off, at least something is buoying your portfolio by moving higher.
A final word of caution: The market is filled with so-called “leveraged” inverse ETFs with the potential for double or triple the gains. But that also means double or triple the losses, making them far more suitable for day traders than buy-and-holders. Avoid them. A small hedging position in SH, however, won’t break the bank in an up market, while still providing much-needed respite in a downturn.
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