If you’ve been an investor for a few years, there’s a good chance you’ve read about, and perhaps encountered firsthand, the summer doldrums in the market.
This phenomenon refers to the lull in the market generally spanning the months of June, July and August. What’s the theory behind the summer doldrums? It’s quite simple actually. Money managers, brokers, financial advisors, hedge fund traders and investors of all walks are distracted by the enjoyable weather during the summer days, which leads to lower volume and arguably leaves the market more vulnerable to volatile swings.
Whether or not that’s true, Wall Street undeniably has a seasonal tendency to be quieter and slower moving during the summer months.
Below we highlight five ways to help your portfolio thrive during an otherwise unexciting period in the market.
1. Lower Your Beta
If you’re worried that your portfolio is susceptible to a steep, unbearable drawdown during the dog days of summer, when low trading volumes can set traps for bulls, then you want to take the approach of lowering your overall beta — that is, your portfolio’s measure of volatility in comparison with the broad market (in most cases, the S&P 500 index).
One way to protect against sharp drawdowns in the event of a low-volume, high-volatility summer is to add exposure to, or substitute one of your existing holdings for, a Low-Beta or Low-Volatility ETF. These funds are built to provide exposure to securities that would appeal to defensive-minded investors. However, this can lull some into a false sense of security. Keep in mind that low-volatility ETFs are equity-based products after all and, like all financial securities, prone to sharp drawdowns with no warning.
2. Add Tactical Inverse Exposure
Some may wish to take advantage of the market’s vulnerability by profiting from downside volatility through inverse equity ETFs. Consider the following 20-year seasonality chart for the S&P 500 and note the range-bound nature during the months of June, July and August:
If you’re going to express a bearish opinion in the market, regardless of the season, remember to consider the pros and cons of buying an inverse ETF versus shorting the long version. Although inverse ETFs are more convenient for most, the precision offered through a traditional short-selling approach is unparalleled.
Read about How to be a Better Bear.
3. Maximize Yield (With Equities)
One way to beef up the income from your core equity position is to embrace BuyWrite ETFs, which employ the covered call strategy. Many of these ETFs pay above-average dividend yields, and some like (QYLD ) do so monthly. The key appeal here is that these ETFs can offer a nice cushion during stagnant or declining markets; however, the covered call strategy will likely underperform if equity markets rally.
Learn more about BuyWrite ETFs here.
4. Maximize Yield (With Bonds)
You can get more yield while geographically diversifying your fixed income portfolio through the use of Emerging Markets Bond ETFs.
Taking on debt with a lower credit quality may deliver juicier returns without having to necessarily take on excessive risk. One key consideration here is your currency exposure: local currency versus U.S. dollar-denominated. Local currency–denominated ETFs are generally more appealing to growth-seeking investors, whereas U.S. dollar–denominated ones are often preferred by those who are hesitant to dip their toes into unfamiliar asset classes, such as EM bonds, to begin with.
Read more about The Right (and Wrong) Way to Tweak your Bond Exposure.
5. Lower Your Correlation
Seasoned investors recognize the benefits of adding tactical exposure to an asset that maintains low, or even negative, correlation with other components in their portfolio — that is, valuable diversification benefits. There’s a plethora of alternative strategies to pick from that are accessible in the ETF wrapper, including:
The key nuance here is that each strategy comes with a unique set of factors that you must evaluate before moving onto comparing products. You should first narrow down the type of strategy you wish to access, and then find and compare the relevant products. In other words, don’t start to pick a Hedge Fund ETF by looking at the expense ratios.
The Bottom Line
Financial markets are inherently unpredictable, so trying to profit from a well-known phenomenon, such as the summer doldrums in this case, is not a reliable strategy to accumulate or preserve capital. Nonetheless, the portfolio tweaks suggested in this article may help you better prepare to take advantage of opportunities during the summer months.
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