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5 ETFs To Consider Today If You Think The Bear Market Is Imminent

Rotation strategies, options overlays and pure downside hedges all have the potential for generating positive returns in down markets.

The S&P 500 (SPY) is about 4% off of its highs as I write this. The Dow (DIA) is down about 5%. The Nasdaq (QQQ) is off about 6% and the Russell 2000 (IWM) is in correction territory, down 11% from its highs. Those numbers alone aren't reason for panic, but when stocks have rarely been more than 5% off their highs for well over a year, investors tend to get more spooked than usual.

It's not entirely without reason though. The omicron variant of COVID is looking like it could be a much bigger issue than originally anticipated (the current estimate is that cases double every 3-4 days). Europe is already seeing reinstituted lockdowns and it's not out of the question that we could see them again in the United States. If businesses begin closing or reducing hours, that impacts economic growth and that will get risk assets' attention. There's a distinct possibility that things get worse before they get better.

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Investors have already begun pivoting towards defense. Utilities, consumer staples and healthcare have been leading the market over the past couple of weeks, while Treasury yields continue to drop.

If you're looking at layering some protection on your portfolio, there are some solid ETF options out there. I'm not talking only about standard utilities or Treasury ETFs, but ETFs that implement unique strategies that attempt to either generate gains during down markets or provide varying degrees of downside protection.

Innovator U.S. Equity Ultra Buffer ETF - January Series (UJAN)

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The buffer ETFs, those that use options strategies to protect against a certain level of downside in exchange for capping some upside, have become incredibly popular over the last couple of years. What started out as just a handful of funds for Innovator has morphed into a suite of more than 50 ETFs covering large-caps, small-caps, emerging markets and others.

Innovator has three levels of buffer. The standard "buffer" protects against the first 9% of losses over the entire outcome period. The "power buffer" protects against the first 15%. The "ultra buffer" protects against losses from -5% to -35%. The catch, of course, is that the more protection you want, the lower the cap on positive returns over the outcome period.

I mention "outcome period" because in order to achieve the expected returns or loss protections, one would have to own the buffer ETF for the entire period. In the case of UJAN - which tracks the SPDR S&P 500 ETF (SPY) - you'd need to buy the fund on January 1st and hold it until December 31st. Own the fund over any different time frame and your results could be different.

Even though UJAN protects against as much as 30% of losses, it currently has a return cap of 6.8%. If the market didn't happen to correct, UJAN shareholders could still enjoy returns of up to nearly 7% if large-caps were to continue rising. If you're a big believer that a crippling bear market is coming, UJAN would offer the most protection. Its next outcome period begins in about a week and a half.

Cambria Tail Risk ETF (TAIL)

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This fund is a pure downside hedge. It intends to invest in a portfolio of "out of the money" put options purchased on the U.S. stock market. It could offer the potential advantage of buying more puts when volatility is low and fewer puts when volatility is high. At any given time, a portion of the fund's assets will be invested in the basket of long put option premiums, but the majority of fund assets will be invested in intermediate term US Treasuries.

Cambria is very straightforward in discussing the return profile of this fund. According the fund's website, "Cambria expects the fund to produce negative returns in the most years with rising markets or declining volatility." Over the past three years, TAIL has averaged a loss of nearly 3% annually, but when volatility spikes and stock prices declined, TAIL has done a great job of kicking in. During the COVID bear market of early 2020, TAIL gained roughly 30%.

Simplify U.S. Equity PLUS Downside Convexity ETF (SPD)

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SPD works very similarly to UJAN in that has a core position in the iShares S&P 500 ETF (IVV) while buying S&P 500 put options of various expiration dates and strike prices. The fund anticipates purchasing options on a monthly, quarterly and annual basis depending on the fund's rebalancing requirements and gives itself the flexibility to rebalance more frequently if high market volatility warrants it.

SPD is just a little over a year old, so there's not a whole lot of data to work with (and certainly not a period with a significant pullback in stock prices). It has trailed the S&P 500 modestly, which would be expected given the structure of the fund. Its $377 million in assets demonstrates that there is a clear demand for this type of product.

AGFiQ U.S. Market Neutral Anti-Beta ETF (BTAL)

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I've mentioned this fund several times in the past as an option for people looking to add a hedge to their portfolio. BTAL is a long/short strategy fund that takes a 50% long position in low beta U.S. stocks and a 50% short position in high beta stocks. The short position pretty much assures that the fund will likely produce negative returns over the long-term, but could be ideal during short-term pullbacks.

The long low beta/short high beta nature of the portfolio means that BTAL will generate gains whenever low volatility outperforms, regardless of whether the market is going up or down. During bear markets, it's reasonable to expect that high beta will underperform low volatility. In theory, BTAL would, in that scenario, generate positive returns while the broader market declines. Like TAIL, this fund should mostly be considered a risk hedge.

Disclosure: I own shares of BTAL.

ATAC U.S. Rotation ETF (RORO)

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RORO is a fund that uses a quantifiable rotation strategy that moves back and forth between stocks and Treasuries depending on conditions. When intermarket asset price movement suggests the conditions are turning more volatile, the fund rotates into Treasuries. When they suggest that the markets are looking calmer, it pushes into stocks.

RORO is not a pure risk hedge in the way that TAIL might be, but it typically sees a much narrower range of returns. Upside and downside capture have both typically been much lower than the broader market, but in an ideal scenario, the net positive upside/downside capture ratio allows shareholders to outperform, while mitigating a significant degree of downside risk.

Disclosure: I have a business relationship with Toroso, the issuer of RORO.

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