If the bull market lasts into March 2019, it will have run for a full 10 years. With the next bear market long overdue, investors are increasingly interested in protecting their gains with hedging strategies. Short sales of futures contracts linked to stock market indexes is one method. Buying put options on an index or on the individual stocks in a portfolio is another. Another approach is simply to lighten up on stocks in general, and rotate the remaining the equity holdings into more defensive or value stocks. (For more, see also: 4 Ways to Avoid Big Losses in the Next Recession: JPMorgan.)

For those who prefer to hedge via short selling, they can buy into a short ETF which does the short selling, and is designed to invert the return on an index (for example, if the index is down by 10%, the fund is up by 10%). The most popular short ETFs (also called bear ETFs or inverse ETFs) track benchmarks linked to hot tech stocks, and seek to deliver positive returns that are a multiple of any decline in those benchmarks, Barron's reports. Meanwhile, there are just four actively managed short ETFs that use more sophisticated approaches to do better than simply inverting the return on an index, Barron's adds. These are listed in the table below.

A New Way To Bet Against The Market

ETF Name Ticker
AdvisorShares Dorsey Wright Short ETF DWSH
AdvisorShares Ranger Equity Bear ETF HDGE
Virtus Enhanced Short U.S. Equity ETF VESH
WisdomTree Dynamic Bearish U.S. Equity ETF DYB

Source: Barron's

What Matters for Investors

These actively managed short ETFs represent another potentially valuable tool that investors can use to protect their equity portfolios against the next market crash. They all take slightly different approaches, and thus have had divergent results in the current bull market. (For more, see also: Top 4 Inverse ETFs for a Bear Market.)

"There's a long history of academic research showing that weak momentum stocks tend to dramatically underperform the market over time," as John Lewis, senior portfolio manager at Nasdaq Dorsey Wright, told Barron's. As a result, the Dorsey Wright ETF essentially is the opposite of a momentum-driven fund that takes long positions in the stocks that show the strongest momentum, or upward price movement relative to the market as a whole. This fund was launched in July, and the table below summarizes the key methodologies employed by its managers.

How One ETF Shorts The Market

AdvisorShares Dorsey Wright Short ETF (DWSH)
Actively managed
Proprietary system ranks stocks based on relative strength or weakness vs. the market
Shorts the 80 to 100 weakest large cap and mid cap stocks, per its ranking system
Updates its portfolio weekly, based on the latest results of the ranking system

Source: Barron's

The Virtus ETF also uses quantitative formulas, in part. Half its portfolio shorts the five sectors that showed the weakest performance in the last nine months. The other half consists of short futures contracts on the S&P 500 Index (SPX).

The Ranger ETF's managers perform fundamental analyses of companies' financial reports to uncover cases of creative accounting, such as "pulling forward their revenue," to mask underlying weaknesses, then short these stocks. The Ranger ETF was launched in January 2011, and it has delivered gains in 5 of 6 subsequent down periods for the S&P 500 that were considerably more than the inverse of the percentage losses for the index, per Barron's. 

By not using leverage, the Ranger ETF has managed to keep its average annualized loss over the past five years to 12.5%, during which time the S&P 500 gained an average annualized 13.5%. A short hedge fund run by the same managers was up by 80% net of fees in 2008, without using leverage or derivatives, while the S&P 500 fell by 37%, Barron's adds.

The Wisdom Tree ETF uses various fundamental analyses of the market as a whole to determine whether it should take a bullish, neutral or bearish stance. When bullish, the fund has long positions in 100 stocks that are screened based on growth and valuation metrics, but it hedges 75% of the portfolio with short sales of S&P 500 futures. When neutral, it hedges 100% of the portfolio. When bearish, it holds only U.S. Treasury bonds and short S&P 500 futures.

Right now Wisdom Tree is bullish, and has been bearish only three times since its inception at the end of December 2015, per Barron's. From inception through September 2018, the ETF delivered a cumulative total return of 8.3%, without a down year yet, per Morningstar, compared to 50.8% for the S&P 500.

Looking Ahead

The bearish ETFs profiled above all have short track records that do not include performance in a true bear market. Also, by their very nature, they are either down or seriously lag the market when the market is on an upswing. Whether future gains posted by these ETFs in the next bear market will offset their bull market underperformance is a big unknown. Investors thus should approach these funds with caution.