Are we headed for a crash or is this week's slide just another market dip?
It's too early to tell, but that doesn't mean investors in exchange-traded funds can't start getting a little more defensive with their portfolios.
The first step to protecting your portfolio is to assess your allocation to cyclical growth stocks. Since Oct. 3, the technology sector, which has driven most of the market gains this year, has taken a nosedive. According to ETFdb.com, the worst-performing ETF over the last week, excluding inverse and leveraged funds, is the actively managed AdvisorShares New Tech and Media ETF. The fund, which holds Amazon, Salesforce and Roku, is down about 13.5 percent.
Other technology funds also took big hits, including the O'Shares Global Internet Giants ETF, down about 11 percent, while emerging market ETFs with a technology bent also did poorly. The Global X NASDAQ China Technology ETF, for instance, was the third worst-performing fund of the week, down 12.2 percent.
If the market continues to falter, technology ETFs will keep getting hammered, say some experts. The sector has performed so well over the last year — the S&P 500 information technology subsector was up about 30 percent between Oct. 3, 2017 and and the same date this year — that it's only logical these companies would take the biggest hit at the first whiff of trouble. Indeed, the subsector dropped by 8.42 percent over the last week, compared with 4.8 percent for the S&P 500, according to S&P Capital IQ.
Defensive sector funds
Jittery investors may want to move at least some of their money out of tech-heavy ETFs and into more defensive options, such as utility and consumer staples funds, said Todd Rosenbluth, senior director of ETF and mutual fund research at CFRA Research. While utilities tend to suffer when bond yields rise — higher-yielding stocks become less attractive when fixed income payouts climb — they also tend to hold up better than growth stocks in a downturn. "Defensive sectors tend to fall less than the market, though they rise less, too," he said.
Several utilities ETFs have done well over the last week. The Reaves Utilities ETF, for instance, is up more than 3 percent since Oct. 3, while the Invesco S&P 500 Equal Weight Utilities ETF rose by 2.9 percent. Several consumer staples funds also fell less than the market, including the iShares Evolved U.S. Consumer Staples ETF, which dropped by only 0.4 percent and the Invesco S&P 500 Equal Weight Consumer Staples ETF, which fell by 0.37 percent.
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While rotating money out of a high-performing sector into more defensive ones is a good strategy, said Rosenbluth, those who want to protect themselves against the ups and downs of the market can purchase a low-volatility ETF. These funds tend to hold more defensive stocks across several sectors.
The iShares Edge MSCI Min Vol USA ETF (USMV), which Rosenbluth highlights as an appropriate fund for a portfolio, holds companies in technology, health care, consumer staples and financials, among others. Its top five holdings are Pfizer, Visa, McDonalds, Johnson & Johnson and Waste Management. The Invesco S&P 500 Low Volatility ETF (SPLV), which has a higher weighting to utilities than the USMV, is another good option, said Rosenbluth. The two did fall over the last week, by about 3 percent and 1 percent, respectively, but they fared better than the overall market.
Another option is higher-yielding ETFs that have payouts of around 3 percent and 4 percent. While the 10-year Treasury yield has climbed to about 3.2 percent, these funds offer enough income that they're still attractive to investors. One fund Rosenbluth suggests looking at is the Invesco S&P 500 High Dividend Low Volatility ETF (SPHD), which offers both low-vol and high-yield features. It has a 3.83 percent payout, a 53 percent allocation to noncyclical stocks, such as utilities, real estate and consumer staples, and only fell by 0.65 percent over the last week.
"These ETFs tend to be hold defensive-oriented, dividend-yielding stocks that provide a cushion for investors," said Rosenbluth. "This is a way that investors can still participate in the equity markets, which will ultimately turn around."
Short-term bond funds
While bondholders will have to stomach some losses no matter what — when fixed income yields rise, bond prices fall — there are ETFs that can soften the blow, said Rosenbluth.
In general, funds that hold shorter-term duration bonds are better than ones that hold longer-term securities. He recommends the iShares 0-5 Year Investment Grade Corporate Bond ETF (SLQD), which has a 2.32 percent annual payout and holds 99 percent of its assets in bonds that mature in less than five years. The ETF only fell by 0.6 percent over the last week.
Clearly, concerned investors have options. While it's never a good idea to sell out the market, and Rosenbluth doesn't think we're headed for a crash, getting a bit more defensive can be a prudent move in today's more volatile markets. "Investors are using this as an opportunity to rotate out of what's worked, which is risk on equities," said Rosenbluth. "We're not concerned, pullbacks happen."