Wednesday brought another round of market sell-offs as stocks plummeted and bond yields rose. Newly developing as well as ongoing risks create heightened uncertainty for investors. For those looking for potential downside mitigation and volatility dampening, hedged equity strategies are worth consideration this year.
Stocks sold off on Wednesday as investor concerns around the budget bill in Congress grew. Evidence of corporate stress also continues to crop up in the current earnings season. Target reported significant misses and slashed its annual forecasts, citing reduced consumer spending and tariff uncertainty. Last week, Walmart revealed it would raise prices to counteract tariff impacts.
Heightened uncertainty regarding the near-term impacts of tariffs on consumers and the economy create a challenged second half for equities. The constantly evolving nature of U.S. tariffs also creates unique challenges for businesses domestically and abroad. Stressors in the U.S. bond market further compound investor concerns this year, creating a foundation for ongoing market volatility.
Be Sure to Look Under the Hood
Strategies that seek to mitigate drawdowns and dampen volatility could prove a boon for portfolios. Hedged equity strategies provide both, in many different forms. They invest across indexes, stocks, and even other funds to gain their equity exposures. They then layer in options, futures contracts, or a variety of other derivatives to hedge against drawdowns.
Understanding what’s under the hood is vital when investing in a hedged equity strategy. The degree of hedge differs, as does the upside potential of each hedged equity strategy. Each individual strategy will have its own risk/reward profile, and investors may apply them differently to meet different needs. Some use hedged equity as a means to dampen their equity portfolio’s volatility. Others use these strategies as an alternative to bonds.
Bonds historically provided a noncorrelated offset to equities in traditional 60/40 portfolios. However, stock and bond correlated drawdowns in 2022, and the resultant shock to portfolios that year led many advisors and investors to look for low and noncorrelated alternatives to enhance their portfolios. Hedged equity strategies provide one potential solution by reducing equity drawdown risks and general volatility.
However you choose to use a hedged equity strategy, they appear well-positioned for the current environment of persistent volatility and frequent equity drawdowns. The recently launched T. Rowe Hedged Equity ETF (THEQ) provides long equity exposure by investing in the T. Rowe Price U.S. Equity Research ETF (TSPA ). THEQ also uses futures, swaps, forwards, and options to achieve its goal of mitigating tail risk and generating strong risk-adjusted returns while dampening volatility.
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