Why ETFs are useful in volatile times?

It has been quite a challenging year for investors across various asset classes. The S&P 500 and Dow Jones indices are now trading only a little above this year’s starting levels. More than 200 S&P500 component stocks have fallen into  technical correction – by definition, when a stock price falls more than 20% from its peak, then it is considered to be entering into “technical bear” area. At the same time, yield spreads continue to put considerable pressure on bond traders. No matter whether you are an optimist or a pessimist, one common view shared among all market participants at the current juncture is there will be huge volatility ahead. In Saxo’s Q4 2018 Outlook, our Head of Equity Strategy, Peter Garnry, urged our clients to “find a parachute” as impact is close.

Exchange Traded Funds, best known by their acronym ETF, are securities that track performance of an individual underlying product (or a basket of same) including. but not limited to commodities, bonds, a sector of stocks or an index. ETFs are attractive because of their liquidity, usually low costs and exchange-traded nature. ETFs combine the features of mutual funds and close-ended funds but can be bought and sold throughout the trading day at their net asset value. Across markets, ETFs allow investors to invest globally without the hassle of picking individual stocks or bonds from each country and are therefore a cost-effective and efficient choice.

ETFs have been available in the US since 1992 and in Europe since 1999. By now, ETFs form a $5 trillion industry with an annual growth rate of about 18%. In the US market alone, there are more than one hundred ETF issuers with the handful holding a majority of the market share. BlackRock’s iShare accounted for about 35% of the market share with assets under management (AUM) of more than $1.75 trillion, followed by Vanguard, State Street and Charles Schwab as a fast-growing new entrant.

Investors could utilise ETFs for different investment and trading needs.

Asset class allocation

For long-term investors, you can choose an ETFs that track certain asset classes, an equity index or certain sector to increase exposure to them. For example, an equity investor could buy a bond ETF to have fixed-income exposure. Traditionally, minimum entry requirement for bonds and commodities trading are rather high, retail investors may not have the channels to invest in these asset classes, with ETFs, a new door opens. As ETFs can be traded as conveniently as stocks, investors can easily rebalance their portfolios without buying and selling individual products. Depending on different investment objectives and risk profiles, there are many ETFs to choose from that meet investors’ wealth management needs.

Before selecting an ETF, investor have to have a view as to which asset class or sector they wish to be exposed to. Then they can pull out information on an ETF’s holding and weightage to see if that matches their expectation. If so, it is highly likely the ETF will be the ideal choice.

Hedge Stock Exposure

Investors who already hold some individual stocks can use index ETFs or inverse index ETFs to hedge downside market risk. For example, if a client holds some blue-chip component stocks in the Hang Seng index he can trade an Inverse Hang Seng Index ETF. Effectively, any loss in his stocks should be offset by gains in the ETF position.