Volatility has a different reputation depending on who you ask. For growth-seeking investors, there are lucrative opportunities where there is volatility; while in the eyes of more conservative investors, volatility spells danger.
Given the cyclical nature of financial markets, it’s no surprise that most are concerned with encountering “bad” volatility, that is, price movements to the downside. Volatility in itself cannot be avoided entirely, and so investors’ next best effort is to try and reduce the negative implications of this phenomenon on their portfolios.
Put another way, while you can’t eliminate downside volatility in your portfolio altogether, you can do a number of things to make it less fragile during broad market sell-offs. For starters, you can focus on reducing your beta, which is the notion of making your portfolio less-sensitive to swings in the broad market.
Learn more about beta and what it means for your ETF portfolio.
Below, we highlight three simple, but effective, ETF strategies that may help to lower your portfolio’s overall beta
1. Trim Growth, Increase Value
Start with a portfolio review and try to separate your growth from your value equity holdings. If you consider yourself to have a moderate to conservative risk appetite and your exposure to growth stocks greatly exceeds that of value stocks, then it might be time to rebalance.
By trimming your positions in growth securities, and rotating that capital into ones that boast value-like characteristics instead, you can effectively lower your beta while still maintaining the same overall level of equity exposure. In other words, substituting growth ETFs with value ones can be thought of as reducing your risk appetite as opposed to entirely suppressing it (that would be selling your growth stocks rather than replacing them).
Ways to Play
Reduce exposure to Growth ETFs and rotate into Value-focused ones.
See also Value Investing 101.
2. Add More (High-Quality) Debt
There’s arguably no more straightforward way, other than moving to cash, to lower your beta then to add bonds to your portfolio. However, buying more fixed income doesn’t automatically make your portfolio safer; in fact, depending on the environment, adding more bonds could have the opposite effect and make your portfolio riskier.
With that said, short-term U.S. Treasuries can help those looking for a low-beta vehicle to put cash to work.
Consider the different volatility profiles of various bond types (as of 6/10/2016):
| Ticker | Asset Class | Beta |
|---|---|---|
| (SPY ) | Domestic Equities | 1.00 |
| (SHY ) | Short-Term Treasuries | 0.11 |
| (AGG ) | U.S. Total Bond Market | 0.30 |
| (LQD ) | Investment Grade Corporate Bonds | 0.49 |
| (HYG ) | High-Yield Junk Bonds | 0.59 |
The rule of thumb when it comes to a bond’s beta, though it may vary depending on the market environment, is that a shorter maturity and higher credit quality corresponds with lower volatility.
Read more about the right (and wrong) ways to tweak your bond exposure.
3. Get Defensive With Sectors
Thinking along the same lines as the first “growth for value” strategy outlined above, another way to reduce beta without actually reducing equity exposure is to rotate into defensive sectors. Corners of the market that have a low-beta profile and a “safe haven” reputation during times of duress include:
One key caveat with the so-called “defensive” sectors is to never forget that they are also exposed to market risk like other “risky” sectors, such as tech or energy; in other words, these are equity investments after all, and as such, they are prone to sharp drawdowns with little to no warning just like most other assets out there.
The Bottom Line
Investors who are looking to fortify their portfolios without abandoning exposure to the market may benefit from tweaks and rebalances aimed at lowering their overall beta. The three ETF strategies outlined here make for a solid starting point, though investors are encouraged to conduct their own portfolio review and formalize their investment goals, then develop and approach from there.
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