Portfolio Hedging Series 01

arrows-left arrows-right

Part I: The Significance of Portfolio Hedging

Portfolio Hedging Series
STRATEGYlogo Leverage & Inverse for US Markets
Learn More

Investing involves risk. Market downturns will happen. Having a sound investment strategy can help smooth out the turbulence in your portfolio and save you from getting caught up in a herd mentality of selling low into a down market. What’s the best approach?

There are a number of possible answers. Hedging is one popular strategy for mitigating the effects of market downturns. Before we talk more about hedging, though, let’s examine recent market history to help illustrate the inherent market risks we face every day.

Downturns and Volatility in the U.S. Equity Market

Since 1980, there have been numerous market corrections (defined as a drop of 10% or more) and five bear markets (declines of 20% or more). In the 1980s, we had the Latin American debt crisis and the stock market crash of 1987. The 1990s were spared any defined bear markets, but they were followed by the technology bubble and the financial crisis in the 2000s. In late 2018, the equity market battled a deep correction that nearly entered bear market territory as it digested Fed rate hikes, trade tensions between the U.S. and China, and renewed volatility. Then, most recently, we experienced a sharp bear market driven by the COVID-19 pandemic.

S&P 500 Price Levels 1980–2020

Source: Bloomberg

Volatility in financial markets reached historically significant levels in 2020 as COVID-19 impacted the economy, public health and daily life in the U.S. and around the world. This volatility was of similar magnitude to what was experienced during the financial crisis and market crash of 1987.

S&P 500, 3-Month Rolling Volatility

Source: Bloomberg. Calculated as the standard deviation of 3-month (63 trading days) rolling returns based on daily S&P 500 returns, annualized to 252 trading days in a year.

Fixed Income—Can Bond Yields Go Any Lower?

While bond yields have been on a downward trajectory over the past 40 years, they hit historically low levels in 2020 as a result of the pandemic’s impact on the economy and markets. The Federal Reserve lowered the Fed Funds target rate to 0.00–0.25%. In 2020, the 10-year Treasury yield fell 100 basis points and the 30-year yield fell 74 bps, along the way hitting lows of 0.51% and 1.00%, respectively.1 This had many investors wondering how much lower yields could go. It also presented challenges for investors managing fixed income exposure and portfolios. While the Fed has indicated a willingness to keep its target rate near zero and a commitment to continued asset purchases, there has already been movement higher in longer-term Treasury yields, which can lead to losses in bond portfolios.

Fed Funds Rate and Treasury Yields

Portfolio Hedging to Dampen the Effects of Market Downturns

Investors can consider hedging strategies to mitigate market risk. A hedge, in its simplest form, is an investment intended to move in the opposite direction of an asset in your portfolio that you consider to be at risk. A hedge provides inverse exposure. If the at-risk investment should decline in value, the hedge is designed to increase in value and offset potential losses in your portfolio.

Hedging is a flexible strategy. You can apply it broadly in an effort to help minimize loss across entire asset classes in your portfolio—to help shield your equity, fixed income, commodity or even currency allocations. Or you can hedge narrowly to help shield individual sectors or even specific stocks. There are a number of hedging strategies available, and the best one for you will depend on your specific needs, goals and tolerance for risk.

Used strategically, portfolio hedging can become part of your long-term investment strategy. Deployed tactically, a hedge can be applied and removed as needed, without disturbing your core strategy or long-term goals, to help provide short-term shelter from adverse market events. Hedging your portfolio can provide you with an alternative to selling in a down market, realizing investment losses and potentially generating significant redemption fees, transaction costs and tax consequences. Of course, hedging strategies have unique risks, costs and consequences of their own (i.e., fund management fees, rebalancing costs, taxable events, etc.). It is important that you fully understand the strategy you plan to use and read the prospectuses for any investments you intend to use as a hedge.

1Source: Bloomberg

Read More

In Part II: Strategies for Hedging Your Portfolio, we delve deeper into the concept of portfolio hedging. We discuss the pros and cons of several common hedging strategies, and we show you why we believe that inverse funds may offer the superior solution. In Part III: The Efficacy of Hedging with Inverse ETFs, we provide concrete examples across asset classes to show you how effectively inverse ETFs can mitigate the effects of market downturns.

Index/Benchmark

Daily Objective

UltraPro Short

UltraShort

Short

-3x

-2x

-1x

BROAD MARKET

S&P 500

SPXU

SDS

SH

NASDAQ-100

SQQQ

QID

PSQ

Dow Jones Industrial Average

SDOW

DXD

DOG

S&P MidCap 400

SMDD

MZZ

MYY

S&P SmallCap 600

--

SDD

SBB

Russell 2000

SRTY

TWM

RWM

SECTOR

Dow Jones U.S. Basic Materials

--

SMN

--

NASDAQ Biotechnology

--

BIS

--

S&P Communication Services Select Sector

--

YCOM

--

Dow Jones U.S. Consumer Goods

--

SZK

--

Dow Jones U.S. Consumer Services

--

SCC

--

Dow Jones U.S. Financials

--

SKF

SEF

Dow Jones U.S. Health Care

--

RXD

--

Dow Jones U.S. Industrials

--

SIJ

--

Dow Jones U.S. Oil & Gas

--

DUG

--

Dow Jones U.S. Real Estate

--

SRS

REK

Solactive-ProShares Bricks and Mortar Retail Store

--

--

EMTY

Dow Jones U.S. Semiconductors

--

SSG

--

Dow Jones U.S. Technology

--

REW

--

Dow Jones U.S. Select Telecommunications

--

--

--

Dow Jones U.S. Utilities

--

SDP

--

INTERNATIONAL

MSCI EAFE

--

EFU

EFZ

MSCI Emerging Markets

--

EEV

EUM

FTSE Developed Europe All Cap

--

EPV

--

MSCI Brazil 25/50 Capped

--

BZQ

--

FTSE China 50

--

FXP

YXI

MSCI Japan

--

EWV

--

FIXED INCOME

ICE U.S. Treasury 20+ Year Bond

TTT

TBT

TBF

ICE U.S. Treasury 7-10 Year Bond

--

PST

TBX

Markit iBoxx $ Liquid High Yield

--

--

SJB

COMMODITY

Bloomberg WTI Crude Oil Subindex

--

SCO

--

Bloomberg Natural Gas Subindex

--

KOLD

--

Bloomberg Gold Subindex

--

GLL

--

Bloomberg Silver Subindex

--

ZSL

--

CURRENCY

EUR/USD 4:00 p.m. ET exchange rate

--

EUO

--

JPY/USD 4:00 p.m. ET exchange rate

--

YCS

--

 

This information is not meant to be investment advice.

Shares of any ETF are generally bought and sold at market price (not NAV) and are not individually redeemed from the fund. Brokerage commissions will reduce returns.

Short ProShares ETFs seek returns that are a multiple of (e.g., -1x or -2x) the return of a benchmark (target) for a single day, as measured from one NAV calculation to the next. Due to the compounding of daily returns, Geared ProShares' returns over periods other than one day will likely differ in amount and possibly direction from the target return for the same period. These effects may be more pronounced in funds with larger or inverse multiples and in funds with volatile benchmarks. Investors should monitor their holding as frequently as daily. For more on risks, please read the prospectus.

There is no guarantee any ProShares ETF will achieve its investment objective.

Investing involves risk, including the possible loss of principal. Short ProShares ETFs are non-diversified and entail certain risks, which may include risk associated with the use of derivatives (swap agreements, futures contracts and similar instruments), imperfect benchmark correlation, leverage and market price variance, all of which can increase volatility and decrease performance. Short ProShares ETFs should lose money when their benchmarks or indexes rise. Please see their summary and full prospectuses for a more complete description of risks.

Carefully consider the investment objectives, risks, charges and expenses of ProShares before investing. This and other information can be found in their summary and full prospectuses. Read them carefully before investing.

Get the latest perspectives and updates.

ProShares ETFs (ProShares Trust and ProShares Trust II) are distributed by SEI Investments Distribution Co., which is not affiliated with the funds' advisor or sponsor.

Your use of this site signifies that you accept our Terms and Conditions of Use.