Hot Summer Volatility & ETFs That Can Handle the Heat


The slow economic outlook coupled with uncertainty over central bank policies and a U.K. referendum have pressured the equities markets. Investors, though, can mitigate the risks by diversifying into exchange traded funds that track safe-haven assets.

Among the list of concerns, an ongoing earnings recession in the U.S., an upcoming U.S. presidential election, an unclear outlook from the Federal Reserve and global economic weakness, especially with risks out of China and potential yuan currency devaluations, have kept investors up at night.

Now, more are growing anxious over the so-called Brexit vote or upcoming U.K. referendum on European Union membership as recent British polling results show a rising percentage are in favor of a break from the E.U.

The Brexit has become a thorn in investors' side, with many looking to the vote as the most pressing issue of the day. The Federal Reserve and Bank of Japan even cited the referendum as a factor in delaying further action in monetary policies.

In response to the uncertainty, U.S. investors have been shifting out of investments and increasing cash positions. According to Bank of America/Merrill Lynch's latest fund manager survey, respondents now have 5.7% of net holdings in cash, the highest percentage since November 2001.

Alternatively, ETF investors can look to other safe-haven plays that may zig as riskier assets zag. For starters, U.S. Treasury bonds have been a go-to safety bet in times of global stress. Long-term Treasury ETFs, such as the iShares 20+ Year Treasury Bond ETF (NYSE:TLT), PIMCO 25+ Year Zero Coupon US Treasury (NYSE:ZROZ) and Vanguard Extended Duration Treasury ETF (NYSE:EDV), have outperformed during periods of heightened volatility.

These Treasury bonds may continue to perform even without the added market risks. After the recent lackluster economic numbers, the Fed is pushing off on an interest rate hike, which should help drive the ongoing search for yield. Some market observers have even argued that the Fed may be forced to only raise rates only once this year. In addition, with over $10 trillion in global bonds showing negative yields, foreign investors may continue to dive into U.S. assets like Treasury bonds in search of relatively more attractive yields.

As a hedge against the market shocks, traders have also turned to gold ETFs, such as the SPDR Gold Shares (NYSE:GLD), iShares Gold Trust (NYSE:IAU) and ETFS Physical Swiss Gold Shares (NYSE:SGOL) - GLD has been the most popular ETF plays, attracting over $10 billion in net inflows year-to-date. Gold is seen as a safer store of wealth during times of turmoil.

Currency traders have also turned to hard currencies and related ETFs to hedge the market fears. For example, safe-haven currency plays include the CurrencyShares Euro Currency Trust (NYSE:FXE), CurrencyShares Japanese Yen Trust (NYSE:FXY) and CurrencyShares Swiss Franc Trust (NYSE: FXF).

The hard currencies are typically used to fund trades of more risky assets due to their low interest rates, along with their stable government and financial systems.

However, when investors reverse risky bets, they buy back the hard currencies, which we are seeing now.

Lastly, within the equities market, investors can also look to utilities as a traditional defensive play, including ETF options like the Utilities Select Sector SPDR (NYSE:XLU), Vanguard Utilities ETF (NYSE:VPU) and iShares U.S. Utilities ETF (NYSE:IDU) that provide broad exposure to the utilities sector.

However, potential investors should be aware that the fortunes of the utilities sector seem to be tied to the Federal Reserve’s interest rate outlook. Once the Fed eventually hikes interest rates, the higher rates will make fixed-income instruments more attractive on a relative basis, and bond-like equities, like utilities, less enticing. Consequently, utilities may remain flat or underperform other segments of the equities market once rates start ticking higher.

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