Four ETF's I Just Bought For Downside Protection In The Event of A Correction

By: Adam Mancini

Is it time to worry about stock valuations? From the perspective of historical valuations, markets appear expensive. The S&P 500 for example, has been up for six consecutive quarters, and over 1000 days without a 10% correction. This would be the longest period without a 10% correction since 1987. Not to mention, the Shiller P/E ratio — which compares the current index price to 10 year inflation adjusted earnings — is sitting at approximately 26.50, well above the mean of 16.55. Markets have a tendency to "mean-revert", that is to say, pull back towards the mean, and this is always a risk when valuations are stretched. Of course, as investors often see with individual stocks, just because something is trading at a high multiple relative to historic prices or its peers, does not necessitate a pull back. Markets can remain overvalued for years or decades. Fundamental macroeconomic indicators are also not particularly conducive to creating the economic environment necessary for a bear market, with job growth establishing a consistent uptrend and interest rates low. Bonds, treasury bills, and cash remain unattractive alternatives. Despite this, the risk of a correction grows as markets climb, and I wanted to begin allocating more funds into a highly diversified group of ETF's with properties that will ensure they decline less than the index in the event of a bear market or correction, while retaining index-matching upside at minimum should markets continue to climb. Here are four Canadian ETF's I just purchased that meet these criteria. Note: For Americans reading, I have listed the similar or equivalent American ETF.

1.  The Horizons BetaPro S&P/TSX 60 Inverse ETF (HIX.TO)

This is an inverse ETF that moves -1x the TSX. If the TSX falls 10% this will rise 10%. Like most inverse ETFs, it does not perfectly track the market, and the degree can vary depending on the time period. For example, YTD the TSX climbed 14.81% and HIX fell -13.23. Nonetheless, for investors fully aware of the risks that can be associated with these instruments, they can be quite useful over short time frames. The American equivalent would be The Horizons BetaPro S&P 500^® Inverse ETF (HIU), or ProShares Short S&P 500 ETF (SH).

2. Vanguard U.S. Dividend Appreciation Index ETF (VGG.TO)

This ETF tracks the US Dividend Achievers Select Index. These are American equities that have increased their dividend every year for the past 10 years. It is similar to the Dividend Aristocrats Index, which has increased dividends every year for the past 25 years.  Because these companies are well-established companies with strong stable cash flows, they often decline less in a recession.  For example, The Dividend Aristocrats index in 2008 was down -21.88, whereas the S & P was down -37%. VIG is the American Equivalent, tracking the same index.

3. iShares MSCI EAFE IMI Index ETF

This is an international ETF that tracks the MSCI EAFE Investable Market Index. This index contains 2,500 holdings from most major non-U.S. economies, and provides a strong global representation. It includes holdings from Japan,  the UK, France, Australia, Sweden, Hong Kong, and many others. Holding this ETF provides a global presence which diversifies from the North American market. It's strong level of diversity protects it from massive declines when Canadian or American markets suffer.  VXUS is an American equivalent which represents a combination between this and the next ETF.

4. iShares Core MSCI Emerging Markets IMI Index ETF

This final ETF is another ETF focusing exclusively on emerging markets, as it tracks the MSCI Emerging Markets Investable Market Index. This ETF has 1,800 holdings in 20 emerging market economies such as China, Korea, Taiwan, Brazil, and India. The idea behind this ETF is that most of the global GDP growth occurring is coming from these economies, and therefore owning this ETF provides exposure to this growth. In addition, should North American economies stagnate and equities with it, holding emerging market stocks should provide some protection or growth. Again, VXUS is the American equivalent, as it holds both Emerging Markets (about 20%) and International stocks.