ETF Safety Nets That Can Cushion the Next Market Crash

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Stock markets have quickly rebounded this year from what looked to be the end of a decade-long bull market. But that doesn’t mean the worst is over. Many investors are worried that the recent rally will soon lose its legs, and are looking for ways to hedge themselves against a potential crash. Timing the ups and downs of the market, however, can be a fool’s errand. That’s why Brad Lamensdorf helped put together the AdvisorShares Ranger Equity Bear exchange-traded fund (HDGE), which eliminates the guesswork of always trying to buy the dips and sell the peaks.

Lamensdorf’s $129 million ETF provides protection through the good times and the bad by selectively shorting only the weakest stocks in the market, rather than shorting the entire market on a hunch that it will soon be heading south. “Forty percent of the entire market is made up of the 40 or 50 best companies, in the United States,” the fund manager told Business Insider. “Is that really what you want to be short,” he rhetorically asked.

AdvisorShares Ranger Equity Bear ETF

(How it works)

  • Stock-picking ETF
  • Shorts weakest equities instead of betting against S&P 500
  • Strategy enables ETF to win in up or down markets
  • Fund managers should use the ETF as a 5% to 15% layer on top of an existing portfolio

What It Means for Investors

In seeking stocks to short, Lamensdorf looks for companies with negative cash flow, poor business models, and those that face significant competitive threats. These are the stock market’s weakest links, and as long as markets contain some degree of rationality, they are likely to underperform relative to stocks of companies with stronger fundamentals. 

As a short-only ETF, the HDGE is not going to outperform in a bull market. But it was never created with the intention of being a long-term buy-and-hold strategy in the first place. The fund is merely meant to be a top layer hedge on an already existing portfolio of equities. Lamensdorf suggests that an allocation in the HDGE ETF of anywhere from 5% to 15% is sufficient.

If the market rises as a whole, the idea is that the weakest stocks should rise less than the strongest. While the weak stocks are still rising, the losses from shorting them shouldn’t be as bad as the gains from going long the stronger stocks. In the case of a market downturn, the bet is that the weakest stocks will get hammered the most. While the long bets will suffer, being short the weak stocks should lead to gains that reduce the damage done on the overall portfolio.

Indeed, with the market heading south in the last half of 2018, the HDGE managed to outperform the market by 3%. Over the past five years, while the fund has slumped 11% on an annualized basis, it has outperformed the typical bear-market fund by 6%. Another similar type of bear ETF fund is the AdvisorShares Dorsey Wright Short ETF (DWSH).

Looking Ahead

Bear ETFs like these are just some ways investors can hedge against market downturns. But when used correctly in combination with long-equity strategies, they can provide significant protection and shave off some of the damage when markets fall.  

Source: Investopedia

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