Hedge Market Exposure With These Innovative ETNs

by on October 26, 2011

Many investors have had a rough time so far in 2011 as a number of issues have plagued markets around the world. European debt crises appear to be in the news every other day while an increasingly large number of emerging markets appear to be abandoning their focus on fighting inflation. This has pushed many investors back into American securities, however this too has been a losing pick as broad indexes have slumped thanks to a lower credit rating for U.S. government debt and weakness in job prospects for a variety of industries. 

In fact, the gold-standard of the ETF world and a mainstay of many investors’ portfolios, the State Street’s SPDR S&P 500 Fund (SPY), is still down in year-to-date terms, posting a loss of 4% since the start of the year. Returns over the past half year period and previous quarter are no better, as these time frames see SPY slumping by an even greater 8%. Although the product has come back in recent weeks thanks to moderating fears over the economy, concerns still remain for this ultra-popular ETF going forward into 2012 [read Alternatives To The 20 Most Popular ETFs]. 

While this very popular fund has faced some significant headwinds in 2011, not all of the ETFs in the Large Cap Blend ETFdb Category have faced the same issues. Some of the more dynamic funds, or at least those that use hedging strategies, have been able to skirt by much of this disaster and actually provide investors with huge gains in the process. These products have used positions in gold, volatility, and cash– or a combination of some of the three– to cycle in and out of markets to the benefit of investors in this rocky time period [read Some Active ETFs Earning Their Keep During Crisis]. 

Although, it should be noted that these funds are far more expensive than their more traditional counterparts, charging investors nearly 10 times the fees for their services while providing much less in terms of liquidity. Yet, in times of market turmoil like we have seen so far this year, they have certainly proven their worth to most investors and have justified their relatively high expense ratios [see Large Cap ETFs: Studs And Duds]. Below, we take a closer look at some of these outperformers and how they match up to the more popular products in the space: 

Barclays ETN+ S&P VEQTOR ETN (VQT)

This interesting ETN from iPath seeks to give investors a way to play broad markets, volatility, and cash, in a single ticker. The fund tracks the S&P 500 Dynamic VEQTOR Total Return Index which looks to provide investors with broad equity market exposure with an implied volatility hedge by dynamically allocating its notional investments among three components: equity, volatility and cash. The ETN decides its allocations based on current market volatility by assuming that volatility in the markets tends to correlate negatively to the performance of American equities. When volatility is low, the product goes heavily into U.S. equities, but as volatility surges, the product shifts towards investments in VIX short-term futures instead. Lastly, when markets get especially choppy, the fund has the option to divert all of the assets into cash in order to protect the investment [see more on VQT's Fact Sheet]. 

The fund is quite a bit more expensive than SPY, coming in at 95 basis points a year in fees. However, the fund has thoroughly crushed its more popular counterpart over long time horizons, gaining close to 17% over the year-to-date period. This represents outperformance of nearly 1,800 basis points in a little over nine months, suggesting that the extra fees have been well worth it in this case [see September's ETF Studs: Five Funds That Thrived During A Wild Month]. 

E-TRACS S&P Gold Hedged ETN (SPGH

This ETN from UBS uses gold to give investors a hedged play on the markets, a potentially interesting play since gold and broad markets often move in opposite directions. This is done by tracking the S&P 500 Gold Hedged Index which is a benchmark that seeks to simulate the combined returns of investing equal dollar amounts in the S&P 500 Total Return Index and long positions in near-term exchange-traded COMEX gold futures contracts, providing exposure to U.S. large-cap equities along with a potential hedge against periodic declines in the value of the U.S. dollar, as expressed in the corresponding increases in the price of gold. In other words, the fund simulates an investment that is 50% gold futures and 50% S&P 500, giving investors the option to play both assets in a single ticker [see returns of SPGH here]. 

In terms of fees, this fund is, once again, far more expensive than SPY, charging investors 85 basis points a year in fees. Fortunately, for those that have bought the product, this investment has been well worth it, as SPGH has crushed the broad markets gaining nearly 20% so far in 2011 and 36% over the past 52 week period. For investors looking for other options in the space that could perform well in rocky times, SPGH could make for a decent choice as well [These Aren't Your Grandfather's Gold ETFs]. 

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Disclosure: No positions at time of writing.