How can ETF investors weather a bear market?


By Rajesh Cheruvu

Stock markets have corrected from their October 2021 highs, and investors have experienced periods of heightened volatility induced by the Russian-Ukrainian conflict, runaway inflation, rising interest rates and monetary tightening.

Investors concerned about market downturns may find opportunities by investing in ETFs to navigate these bear markets.

While picking individual stocks can be risky, there are several ETFs designed to withstand bear markets that may suit an investor’s style and risk tolerance. ETFs have now become an easy and preferred way for many investors to gain exposure to the stock market, not only providing broader market exposure, but also allowing them to focus on specific sectors, themes, strategies and specific styles according to their preference. .

ETFs are a low-cost passive investment alternative that gives investors exposure to stock markets.

Volatility tends to spike during periods of market turbulence due to uncertainty about macroeconomic conditions. During such bear markets, investors can opt for low volatility ETFs which tend to do well in volatile market environments. The stocks that make up low volatility ETFs are those with relatively low volatility, limiting downside risk during bear markets and cushioning portfolios.

Beta is a popular measure of volatility relative to the broader market. Therefore, an ETF with low beta stocks allows investors to maintain their equity exposure while reducing their exposure to broader market volatility.

Dividend-paying stocks typically outperform in high inflation environments. Investors could therefore do well in such environments by investing in ETFs exposed to large-cap stocks with higher dividend yields.

In previous bear markets, these ETFs have not only outperformed large caps, but also the broader market. The stocks that are part of these ETFs provide stable dividends and are often part of defensive sectors, which are more likely to withstand economic downturns and increased volatility compared to cyclical sectors, thereby maximizing yield and providing stability to portfolios. .

Large-cap, equal-weight ETFs are another promising avenue for investing in bear markets, as significant market declines are typically followed by a broad-based market rally, in which equal-weight ETFs have historically outperformed.

These ETFs provide exposure to large companies with equal weight to each stock, reducing stock and sector concentration risk. It provides an equal opportunity to the bottom stocks of a market-cap-weighted index to perform and contribute to performance during a secular recovery by capitalizing on broad-based economic growth.

Since consumption is one of the central themes underpinning India’s structural growth story, investors can also seek refuge in a consumer thematic ETF. They offer investors exposure to key sectors such as consumer goods and services, automotive, textiles, telecommunications and healthcare services, and others where demand is typically secular. India’s large youthful population, rising income levels, growing retail penetration, growing demand for luxury/branded goods are all supporting India’s consumer sector, with a huge growth potential.

Additionally, from an investment perspective, thematic consumer ETFs have outperformed broader market indices during major downturns, mitigating downside risk and volatility.

The ETFs mentioned above can help investors limit the downside of their portfolios as well as the potential for markets to outperform in a state of turbulence. However, some of them could underperform once the markets start to pick up. Therefore, they should be used tactically to complement the core portfolio which is aligned with the investor’s risk appetite and overall asset allocation. Investors should also avoid trying to time the market trying to catch the peaks and troughs of the market and pursue the steady rollout through the SIP route to experience the long-term compounding benefits of stock markets.

(The author is Chief Investment Officer, Validus Wealth)


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