Bear Proof Any Portfolio with a New ETF
05/15/2012 9:00 am EST
A relatively new, actively managed ETF is an attractive way for traders and investors to profit from market downswings and/or hedge existing long positions, explains John Nyaradi.
Last week’s news was chaotic and scary at best as Greece descended into near anarchy and Spanish bond yields rose to frightening levels. France’s new government appears ready to go to war with Germany and unwind the uneasy peace in Europe, while the US continues to be hit with less-than-stellar economic reports and new chaos in the financial system on the heels of JPMorgan’s blockbuster loss last week.
Couple this with recession spreading across Europe, a slowing Chinese economy, and the upcoming US election season, and it’s easy to make an argument that a new bear market could soon be on the prowl.
My thesis is that the volatility we’ve seen over the last several years is going to continue for a long time to come. It’s very likely that we’re in the middle of a long-term, secular bear market that began in 2000 and could continue for many more years. This bear has been fed by the tech wreck of 2000, the financial collapse of 2008, and most lately by the financial crisis in Europe.
Going forward, it will likely find more fresh meat in the debt problems in the United States and the aging global population, which will further stress national resources both in the United States and throughout the developed world.
Within this secular bear, however, there will be opportunities to make money on both the up and down side of the wild market swings we will likely see.
During its 20+ year secular bear, Japan has seen double-digit rallies and double-digit declines, and we are likely to see the same as we go through time. It’s relatively easy to make money by going long during the bull market phases, like the one that ran from 2003-2007, but then most of that and more is given back during the downswings like the one that started in 2008.
Since March, 2009, we’ve been in another upswing that could likely be followed by an equally impressive decline if the situation in Europe should get out of hand and the world enters a double-dip recession, which is becoming a more likely possibility with each passing day.
So if we’re at the beginning of a significant downswing, which is a likely possibility, what is an investor to do?
One option is to flee to the safety of cash. Another option is to just “ride it out,” to buy and hold as we’ve been taught to do for years, or to dollar cost average and hope that over time we’ll end up in the black. But there’s yet another option, and that is to invest in ETFs designed to make money during bear market declines.
To do that, one can use inverse ETFs, which come with their own set of pros and cons, or we could consider a relatively new ETF that has hit the investing scene with great excitement and seems to have great potential for seeking profits during bear market declines.
To counteract a possible bear bite, investors could look to a relatively new exchange traded fund, the AdvisorShares Active Bear ETF (HDGE) for a way to profit from any potential oncoming global upheaval or massive market correction.
Here is a daily chart:
Active Bear is part of a relatively new class of ETF, those which are actively managed, and this particular one offers “short” exposure to equity markets through the short sales of domestic securities.
It short sells a portfolio of 20-50 liquid US traded equities in an attempt to outperform during market declines and offer a hedging vehicle during normal market conditions. It looks for companies with poor earnings quality, accounting problems, or earnings events that could lead to lower share prices and then shorts those stocks.
As an actively managed ETF, it comes with a management fee that will lower overall return. However, it also offers the significant advantage over inverse ETFs of not having the tracking error that is inherent in these products because they are priced on a daily basis and can compound against you if the underlying index moves against your position.
See also: The Hidden Danger in Some ETFs
A quick glance at HDGE shows us that it closely traces an inverse path to major US indexes like the S&P 500. As the S&P goes up, HDGE goes down, and vice versa. In recent days, we can see that HDGE is in a strong uptrend while the major markets swoon.
HDGE has grown fast since its inception less than 18 months ago and now sports more than $250 million in assets under management, as retail and professional investors alike flock to the fund to either hedge current long-term positions or make directional plays on the current correction that seems to be unfolding.
It seems like it could be a solid bet for investors who are less than optimistic about the future direction of the US stock market, or for those who want to hedge current positions they own.
The fund offers the potential to protect one’s portfolio from another unwelcome bear bite, and it can also be useful in normal market conditions because it offers a way to hedge equity exposure for buy and hold investors, diversify one’s portfolio, and find companies whose share prices could decline even while the broader indexes are in an uptrend.
Buy and hold investors can use it as a hedge while more active traders can use various technical trading techniques to go long the ETF when market conditions indicate a correction is in store and then exit their positions or even short HDGE when it looks like a new uptrend in major indexes has resumed.
In all, HDGE offers investors a sophisticated vehicle to seek profits and minimize losses in today’s secular bear market which shows no sign of ending anytime soon.
By John Nyaradi of WallStreetSectorSelector.com