Self-Defense With ETFs

10/17/2011


 

The average stock in the S&P 1500 Index has plunged 18% since the index's early-July high. History suggests much of the carnage is behind us. But with stocks swinging wildly and the primary trend in the bearish camp, a somewhat defensive posture remains appropriate.

To that end, we screened for exchange-traded funds (ETFs) with a defensive slant. While not bulletproof or immune to downturns, the funds could offer at least some refuge from market turmoil. Below we review several standouts from five timely categories.

• Income ETFs. Dividend income can provide a cushion when capital gains are scarce. We screened for ETFs yielding more than the S&P 500 Index's 2.3% that have outpaced the index so far in 2011. In addition, we focused on funds with weighted-average Quadrix® Overall scores of at least 60 that have more than one-quarter of assets in stocks with Overall scores above 80. Two notable names include Vanguard High Dividend Yield ($42; VYM), yielding 3.6%, and PowerShares Dividend Achievers ($14; PFM), with a yield of 2.6%.

Sector funds. Funds that focus on traditionally defensive sectors like consumer staples, health care, and utilities tend to hold up better than most in down markets. We screened for funds that have outperformed their peer group and the S&P 500 this year. We also looked for funds with strong Quadrix underpinnings. Three standouts include Vanguard Consumer Staples ($78; VDC), Health Care Select Sector SPDR ($33; XLV), and PowerShares Dynamic Utilities ($15; PUI).

Allocation ETFs. Similar to traditional balanced mutual funds, allocation ETFs hold both stocks and fixed-income investments. These ETFs typically use tactical asset-allocation strategies, so the percentage of assets in stocks, bonds, and cash can vary based on market conditions. One interesting fund, iShares S&P Conservative Allocation ($29; AOK), is 81% invested in bonds (mostly U.S. government) and only 19% in stocks. The fund, which tends to lag in bull markets, is up 2% so far this year.

Inverse funds. These ETFs are designed to post gains when the underlying asset declines. Many use leverage to magnify returns. For example, an inverse ETF seeking a negative return of two times its benchmark should gain about 2% on a day its index dips 1%. Investors should consider inverse ETFs speculative. One popular fund, ProShares Short S&P500 ($43; SH), seeks to return the inverse of the S&P 500 on a single day. So far in 2011, the fund has dipped 1%, while the index is down 3.4%. Inverse ETFs can be useful as a hedge against market declines, but investors should tread carefully and monitor the funds on a daily basis.

Risk-related ETFs. A handful of funds screen for lower-risk stocks. We would expect low-volatility stocks to outgain the market during sell-offs. But over the last 20 years, a period that includes parts of four bear markets as well as the longest bull market in history, the 100 stocks in the S&P 500 Index with the lowest volatility outperformed the broader index by about 180 percentage points. PowerShares S&P 500 Low Volatility ($24; SPLV) holds 100 stocks from the S&P 500 with the lowest return variation over the past 12 months. Russell 1000 Low Volatility ($46; LVOL) invests in stocks that have a low variability of total returns over the last 60 days. In contrast, Russell 1000 Low Beta ($46; LBTA) holds stocks considered to have a lower beta than the overall market. Beta measures a stock's sensitivity to market movements.

FUND PORTFOLIO WEIGHTS ADJUSTED

Through Oct, 11, our recommended Growth Portfolio has lost 6.6% so far this year, versus a 5.6% loss for its benchmark portfolio. The Conservative Portfolio is down 4.2%, versus a 3.1% loss for its benchmark.

— Year-to-Date —
—– % of Portfolio –—
Fund (Price; Ticker)
Return
(%)
Rank
Conser-
vative
(%)
Growth
(%)
Fund
Rating
American Century Heritage
($19; TWHIX)
(7.1)
C
6
7
70
Buffalo Growth
($24; BUFGX)
(4.1)
C
10
11
75
Dreyfus MidCap Index
($26; PESPX)
(8.2)
B
0
0
75
Dreyfus Small Cap Stock Index
($19; DISSX)
(7.8)
A
0
0
61
Heartland Select Value
($26; HRSVX)
(10.7)
C
4
6
65
Heartland Value Plus
($26; HRVIX)
(12.3)
C
5
6
72
Manning & Napier International
($8; EXITX)
(10.3)
B
7
7
89
T. Rowe Price New Horizons
($33; PRNHX)
0.1
A
7
7
98
Vanguard 500 Index
($110; VFINX)
(3.5)
B
5
5
72
Vanguard Dividend Growth
($15; VDIGX)
(2.1)
A
10
11
100
Vanguard Emerging Mkts.
Stock Indx. ($24; VEIEX)
(19.5)
C
0
4
90
Vanguard GNMA ($11; VFIIX)
5.8
B
10
5
91
Vanguard Inter.-Term Tax
Exempt ($14; VWITX)
6.0
B
0
0
86
Vanguard Short-Term Invest.
Grade ($11; VFSTX)
1.1
B
7
6
85
Vanguard Total Bond Mkt. Index ($11; VBMFX)
5.5
A
10
0
78
Vanguard Total Int'l Stock
Index ($14; VGTSX)
(13.7)
C
4
4
82
Vanguard Wellesley Income
($22; VWINX)
4.1
A
0
0
99
Vanguard Wellington
($30; VWELX)
(1.1)
A
6
9
97
Wasatch International Growth
($18; WAIGX)
(11.9)
B
4
6
91
Wells Fargo Advantage High
Income ($7; STHYX)
(0.7)
A
5
6
66
* Year-to-date ranks through Oct. 11 from Morningstar, comparing performance among funds with same objectives. A = top 20%; B = next 20%; C= middle 20%; D = next 20%; E = bottom 20%. Fund ratings are percentile ranks based on our fund-rating system.

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