Five ETFs For The Next Recession

by on November 30, 2009 | ETFs Mentioned:

Despite still rising unemployment, abysmal consumer confidence, and signs of ongoing crises around the world, there is little doubt, at least technically speaking, that the recession is finally over in most of the world. The downturn proved to be far more severe and prolonged than many had imagined, leaving its mark on even the most conservative of investors. Diversification across asset classes provided little benefit, as bonds and real estate fell along with equity markets. Geographical diversification also did little to protect investor assets, as correlations between most developed and emerging markets shot towards 1.0.

Black SwanBut not all investments saw huge losses during the most recent recession. Some actually enjoyed tremendous gains, benefiting from strong negative correlations with traditional asset classes and bucking the trend to deliver positive results.

Perhaps the best-known example is the Black Swan Fund run by 36 South Investment Managers Ltd. that delivered tremendous returns during the depths of the recession. The fund bet on rare and unexpected events, including interest rate cuts in Australia and New Zealand, and bought put options on many emerging markets. In a year full of disasters, the “disaster hedge” fund delivered returns of more than 230% to some of its investors.

ETF Options

Another recession at some point in the future is a near certainty, but the when and where is up for debate. Some think it has already begun, predicting a “double dip” brought on by failure to appropriately strengthen the financial system and abundance of cheap money in the U.S. and several other countries. Others think the road to recovery will be a more traditional “V-shaped” one, dotted with significantly fewer obstacles and steadily rising stock prices.

For investors without the required cash to invest in hedge funds, there are a number of more readily available exchange-traded options that performed relatively well during the most recent recession. Some are traditional “safe havens” while others are new, innovative products that offer new ways to invest in an extended bear market. With the most recent stock market collapse still close in the rear view mirror, we take a look at five exchange-traded funds that investors should keep in mind the next time a downturn appears to be at hand. For more actionable investment ideas, be sure to sign up for our free ETF newsletter.

  • iPath S&P 500 VIX Short-Term Futures ETN (VXX): The CBOE Volatility Index, better known as the VIX, has been one of the most closely-watched indexes for nearly two decades. But the ability to invest in this benchmark is a relatively new development. Volatility had a strong negative correlation with most equity benchmarks in recent years, as the VIX rose from its long term average near 20 in August 2008 to more than 80 in November of the same year. VXX wasn’t introduced until early 2009, but since inception its correlation with the S&P 500 has been a remarkable -0.97. VXX won’t always track the VIX directly – it invests in first and second month futures contracts – but it will come pretty close.
  • SPDR Gold Trust (GLD): Gold is one of the oldest and most popular safe haven investments, and the rise of the ETF industry has only boosted its presence in investor portfolios. Between September 2007 and the bear market lows in March of this year, GLD gained nearly 25% as investors sought out the security of precious metals amid tumbling asset prices (for a complete look at ways to invest in gold both directly and indirectly through ETFs, see this complete guide).

GLD Has Shot Upward Over The Last 3 Years

  • ProShares Short Financials (SEF): As the epicenter of what became a far-reaching crisis, the U.S. financial sector was among the hardest hit asset classes over the last two years. SEF, which seeks to deliver daily returns equivalent to the inverse of the Dow Jones U.S. Financials Index, saw a spike as the scope of the financial crisis continued to expand. If comprehensive reforms are effective in protecting the financial sector from another massive meltdown, it could be unlikely that SEF would see huge gains in the next recession. But that’s a big “if.”

SEF Jumped During The Recession

  • MacroShares Major Metro Housing Down (DMM): Residential real estate was another of the battered asset classes during the recent downturn, as home prices across the country endured a sharp downward correction. DMM is part of the paired product offerings from MacroShares that pledges assets to each other based on the level of the S&P/Case Shiller Composite-10 Home Price Index. DMM can serve multiple purposes for investors, either acting as a hedge for homeowners or an effective way to bet on a further decline in single family home prices.
  • iShares Barclays 1-3 Year Treasury Bond (SHY): One of the most conservative investment options available through ETFs, SHY came through the recent recession relatively unscathed. Despite the massive amounts of debt issued by the U.S. government, investors remained confident in the quality of Treasuries. Between September 2007 and March 2009, SHY gained about 8%. Not exactly a “get rich quick” return, but at a time when capital preservation becomes a top priority, this kind of gain looks pretty good.

Hopefully we won’t need these ETFs

Disclosure: No positions at time of writing.