As we barrel towards the Niagara Falls of all fiscal cliffs, investors seem fairly certain that additional volatility is in store for the next few months. What is less clear, however, are the strategies that can be effective in insulating portfolios from a surge in uncertainty-related volatility over the next several weeks [see also Free Report: How To Pick The Right ETF Every Time].
Inspired by some of the thoughts put together by the folks at iShares, we outline five strategies below for reducing overall risk and volatility in your portfolio, as well as some specific ETF options for each approach.
- Low Volatility Stocks: This approach is perhaps stunningly obvious, but it’s worth highlighting given the innovations in the ETF industry in recent months that make implementation easier than ever. For investors expecting a rise in volatility and significant downside risk, low volatility stocks represent a way to scale back overall risk while still keeping skin in the game (ie, keeping overall equity exposure the same). There are a number of low volatility ETFs out there now; the PowerShares S&P 500 Low Volatility Portfolio (SPLV, A-) is by far the most popular, but there are other options targeting developed and international markets outside the U.S [see our Low Volatility ETFdb Portfolio].
- Mega Cap Stocks: Another option for investors looking to scale back risk while maintaining their existing equity allocation is mega cap stocks. While these companies aren’t immune to uncertainty and volatility, they tend to exhibit greater stability than smaller companies. Because they generally have established operations and significant cash balances, mega caps can be a way to reduce overall volatility. Again, there are a number of mega cap ETF options here; funds such as OEF and MGK tap the U.S. market, while FEZ, IOO, DGT, and ADRE focus on international mega cap stocks.
- Hedge Fund Strategies: The idea of a hedge fund strategy might seem contradictory to risk reduction, but that relates to misconceptions about what hedge fund replication really seeks to achieve. The goal is not a risk on, shoot-for-the stars approach, but rather an attempt to reduce overall volatility and achieve returns that exhibit low correlation to stocks and bonds. Comparing the overall volatility of a product like the IQ Hedge Multi-Strategy Tracker ETF (QAI) to SPY, for example, illustrates this point quite effectively. There are a number of hedge fund ETFs that offer relatively low volatility, making this alternative strategy potentially very appealing now [see Cheapskate Hedge Fund ETFdb Portfolio].
- Precious Metals: The gold bugs may have their day yet; after slogging along for most of the year, precious metals prices have popped since the election. That could be a good indication that hard assets–specifically gold and silver–will be the primary beneficiaries of any prolonged gridlock in Washington. There are a number of ETFs offering exposure to both gold and silver, as well as several broad-based precious metals funds.
- Cash: This represents the ultimate capital preservation approach–which isn’t necessarily a bad tactic in the current environment. Converting to cash or cash equivalents obviously minimizes the upside–especially with rates near zero–but takes almost all the risk off the table along with it. Before rushing to put your money under the mattress, consider one of the several money market ETFs that offers modest yield opportunities.
Disclosure: No positions at time of writing.