September 28, 2020 BARRON’S 31
FUNDS
There’s no magic formula: Strategies that protect
on the downside are going to limit gains on the
upside. And they can be overly complex.
TheseETFsCanHelp
ReducetheRiskina
Portfolio. Probably.
I
nvestors still reeling from the
stock market’s 34% crash ear-
lier this year have good reason
to warily eye the market’s
recent volatility—and many
are once again revisiting the
risks in their portfolios. But
that’s easier said than done. Tradi-
tional strategies might not work as
well as they have in the past, and the
rash of new exchange-traded funds
aimed at reducing risk can be overly
complex, and introduce other risks.
The most common approach to re-
ducing risk, of course, is to shift money
from higher-risk assets, like stocks, to
lower-risk ones, like bonds—and
within those categories, owning the
less volatile, more defensive options.
For fixed income, that means favor-
ing government and high-quality
bonds. But investors have bid up
prices to the point that yields are ex-
tremely low. For stocks, defensive sec-
tors such as consumer staples and
utilities, and low-volatility stocks,
often hold up better in downturns.
But they failed to work this year when
the S&P 500 tumbled 34% from Feb.
19 to March 23. The $33.1 billion
iShares Edge MSCI Minimum Vol-
atility USA exchange-traded fund
(USMV) lost a similar 33%, and the
$8.5 billion Invesco S&P 500 Low
Volatility (SPLV) plunged 36%, even
more than the broader market.
“That was certainly disappointing,”
says Alex Bryan, an ETF specialist at
Morningstar. As stocks fell again in
September, the low-volatility funds
seem to have done what they’re sup-
posed to do, losing about two-thirds as
much as the market. Still, Bryan
warns: “They are not always going to
work, even if they do on average.”
ETF providers, of course, have
been devising products that aim to
reduce losses when markets turn
south. They use a variety of strategies,
some more time-tested than others,
but investors need to be wary of new
risks that get introduced.
Tactical-allocation ETFs automati-
cally shift into new asset classes when
certain marks are hit. The $363 million
DeltaShares S&P 500 Managed
Risk (DMRL) is primarily invested in
stocks but moves into Treasuries when
volatility spikes. The $66 million Cam-
bria Global Momentum (GMOM)
owns other funds based on which have
the strongest trailing momentum. Both
ETFs successfully dodged about half of
the market’s losses during the March
selloff, but have lagged ever since.
Trend-chasing strategies like these are
backward-looking by nature, which
means they are usually a step behind.
When trends aren’t clear or shift sud-
denly, they get hurt.
Advisory firm Cabana Group re-
cently rolled out five “target draw-
down” ETFs based on its separately
managed account strategies, launching
them with a total of $1 billion. The
funds monitor various macro indica-
tors to identify where the economic
cycle is, and allocate to more attractive
asset classes accordingly. Depending
on risk tolerance, each fund targets a
different maximum drawdown per-
centage ranging from 5% to 16%—
which determines how aggressive the
reallocation is. The goal, says CEO
Chadd Mason, is to keep losses within
expectations so investors stay invested.
The $918 million Invesco Russell
1000 Dynamic Multifactor (OMFL),
launched in late 2017, applies a similar
approach to allocate assets among fac-
tor groups—or stocks with characteris-
tics like smaller size, cheaper valuation,
or stronger momentum—that move in
and out of favor depending on the
macro environment. Investors in these
strategies will have to trust the judg-
ment of the managers, or algorithms, in
assessing the economy and market
direction. If they are wrong, the fund
could suffer significantly: The Invesco
fund lost just as much as the market
during the March selloff.
So-called buffer ETFs offer another
approach to managing risk. They track
an index like the S&P 500, but use
options to limit losses—which also
limits gains—during a defined time
period. “People have no idea where the
market is ultimately going,” says Bruce
Bond, co-founder and chief executive
of Innovator Capital Management, the
firm that first came up with its Defined
Outcome buffer ETFs in 2018. “For
those who are close to retirement or
just have a very conservative approach
to investing, they are willing to trade
the unknown for the known—that is,
to give up the potential for outperfor-
mance in order to know how much
downside buffer they’ll get.”
Buffer ETFs have become particu-
larly popular amid elevated uncertain-
ties this year. Dozens of new products,
including from First Trust and Allianz,
were launched. Innovator alone nearly
doubled assets in its buffer funds, to
$3.3 billion. Buffer ETFs’ loss protec-
tion is limited. Some Innovator funds
only protect investors from the first 9%
or 15% of a drawdown. In other cases,
investors will need to weather the first
5% loss before getting protected.
The price for protection is the po-
tential of missed opportunity. The
funds cap the maximum gains inves-
tors can get—the more protection, the
lower the cap. The upside cap can be
different at the start of each defined
period, and is often higher as market
volatility rises. If investors trade the
fund before the period ends, the re-
maining upside cap and downside buf-
fer also fluctuate depending on market
movements. That all adds to complex-
ity. “If you don’t understand what
you’re getting and it performs differ-
ently than how you think it should, you
could end up selling at the wrong time
and that could hurt you,” says Bryan.
Risk-averse investors need to re-
member there’s no free lunch. Risk-
mitigation funds might prevent deep
losses, but limit gains. For those with
time on their side, sticking with a di-
versified portfolio and riding out the
volatility might work just as well, says
Bryan: “There really is no magic bullet
when it comes to risk reduction.”B
By Evie Liu
No Magic Bullet
There’s no free lunch when it comes to risk reduction. These funds might prevent deep losses, but they also limit gains.
02/19-03/23
Fund / Ticker Expense Ratio AUM (mil) YTD Return Price Change
iShares Edge MSCI Minimum Volatility 0.15% $33,100 -4.0% -33.0%
USA /USMV
DeltaShares S&P 500 Managed 0.35 363 -4.9 -16.0
Risk /DMRL
Cambria Global Momentum /GMOM 0.93 66 -7.1 -18.2
Invesco Russell 1000 Dynamic 0.29 918 -9.3 -33.1
Multifactor /OMFL
Cabana Target Drawdown 7 /TDSB 0.68 300 10.9 TBD
Innovator S&P 500 Buffer, October /BOCT 0.80 62 2.1 -24.5
SPDR S&P 500 /SPY 0.10 281,900 1.6 -33.9
Note: YTD returns through Sept. 23; *Historical performance of Cabana advisory accounts that employ similar strategy as the ETF; **Returns have a 9% downside
buffer and 14.1% upside cap for the outcome period between 09/30/2019 and 09/30/2020. Sources: Morningstar; FactSet