Stock investors looking to hedge against the market’s wild swings this year—amid an ongoing trade war, uncertainty over interest rates, and the possibilities of recession and bear markets—might want to consider five low-volatility exchange-traded funds (ETFs) whose holdings offer strong dividend payouts. Comprised of shares of high-quality large cap companies in defensive sectors or with a history of raising dividends, these funds offer investors a way to insulate their portfolios from the erratic ups and downs of volatile markets, according to Barron’s.
They include the Invesco S&P 500 Low Volatility ETF (SPLV), the FlexShares Quality Dividend Defense Index ETF (QDEF), the iShares Core High Dividend ETF (HDV), the iShares Edge MSCI Min Vol EAFE ETF (EFAV), and the iShares Edge MSCI Min Vol USA ETF (USMV).
What It Means for Investors
Two primary factors make these ETFs safer bets in volatile markets: their income component and their defensive component. When markets are seesawing back and forth with no real strong upward trend, shares of companies with a history of paying consistent dividends offer investors a way to continue earning income without capital gains, and defensive non-cyclical stocks tend to do less seesawing with more resilient, albeit, slower short-term growth.
Hedging against volatility is becoming increasingly important in the current economic environment, as the divergence of views on what the Federal Reserve’s next moves will be after deciding to hold interest rates steady on Wednesday. Prior to that decision, CME group said fed-funds futures were indicating an 85% chance of a rate cut in July, according to The Wall Street Journal.
While that prediction is in line with expectations of economists at Morgan Stanley, JPMorgan and Bank of America are both skeptical that rate cuts will happen that early. Goldman Sachs thinks the Fed won’t cut at all in 2019. UBS, which says markets are pricing in a full percentage worth of rate cuts by the end of 2020, thinks that is “a rate of easing that would only be justified by a recession, which we see as unlikely.”
With markets already pricing in rate cuts, even if the Fed meets those expectations there is likely to be little further upside. Indeed, rate cuts may even have the negative effect of signaling to investors that the economy really is in as much trouble as feared. If the Fed fails to cut and disappoints expectations, stocks could make a sharp correction downward as investors revise their expectations. Risk appears to be leaning to the downside.
With a potential for another downward swing, the iShares Edge MSCI Min Vol USA ETF offers a potential safe haven. The fund is weighted towards consumer defensive stocks, utilities and REITs, and tends to lose less in a market downturn while providing between 20% and 30% lower volatility than the market, according to Morningstar’s director of passive strategies research, Alex Bryan. “These are the types of funds you can hold through think and thin,” Bryan told Barron’s.
The iShares Core High Dividend ETF is diversified across sectors and holds shares of companies with a history of raising dividend payouts, including Exxon Mobil and Procter & Gamble. It’s also cheap with fees of less than 0.1%.
While using low-volatility and income-paying ETFs is a smart way to hedge in volatile markets, investors should keep in mind that much of the volatility is being caused by global macro and geopolitical risks. If those risks dissipate, many of the concerns about future economic growth and bear markets will also dissipate, which could reinvigorate the bull market. In that case, these ETFs are unlikely to offer investors outsized gains.