ETFs for Contemporary Crises

 |  Includes: FOL, FSA, FSE, FSG, FSU
by: Marc Gerstein

Usually, market, economic and/or financial crises are horrible for investors and great only for book authors and media outlets, who get much to talk about and audiences hungry to have their fears stoked. But that may be changing. Given the way the ETF world has evolved and the exotic directions it seems to be exploring, investors don’t just have to read, hear and moan about crises. It’s easier than ever for them to try to profit from chaos.

Given the shaky nature of the stock market at present, exacerbated by a debt deal that seems to have united the body politic in its disdain, and my inquiry into ways we might hedge an income-stock portfolio (something I said I’d be investigating in my latest Triple Play Income article), I thought it might be interesting to take a peek into the ETF screener to see if any of the many recent additions to the database might be of interest.

When we developed the screener, I added the category “Hedged” to the Method section of the ETF taxonomy. At the time, I think there were just a couple of ETFs available along those lines, but I suspected the category would grow. And indeed it has. The category as a whole shows 33 ETFs, and if I really want to get fancy and add another screening rule limiting results only to ETFs in the “Mixed Assets” category, I still come up with 13 names (not a geyser, but a heck of a lot more than there were when the ETF screener was launched).

Five of them seem particularly interesting insofar as their workings are very easy to grasp, meaning it’s easy for an investor to decide for himself or herself whether he or she wants to buy in. There is no need to rely on some sort of secret formula concocted by an army of quants speaking a language normal people can’t hope to understand. (Actually, though, empowerment is a mixed blessing: if gives you the ability to profit from making your own choices, but it also gives you the ability to lose if your choices are bad.)

Making things more interesting is that all five seem to address scenarios about which we have legitimate basis for hand-wringing. All come from a fund family known as FactorShares and in all cases, your return is based on a spread (the difference in performance between two things; you don’t care whether they go up or down; all you care about is the difference in performance).

Here they are:

FactorShares 2X TBond Bull/S&P500 Bear (NYSEARCA:FSA): The return here is based on two times the daily difference between Treasury Bonds and the S&P 500 (NYSEARCA:SPY) (implemented via purchase of futures contracts). The fund is long Treasury Bond futures and short the S&P 500. This is the ETF to play if you expect both the stock market and interest rates to decline. It’s been a terrific holding as the debt crisis intensified, and it may still have some short-term legs but be careful; if the stock market continues to decline but interest rates turn upward (i.e. if the Dollar plummets), this fund is going to get slammed hard.

FactorShares 2X: S&P500 Bull/TBond Bear (NYSEARCA:FSE): This is the opposite of FSA. You still get two times the daily difference between Treasury Bonds and the S&P 500, but now, you’d have to be bullish on stocks (the ETF is long the S&P 500) and expect interest rates to rise (it’s short Treasure Bond futures). In the last month or so, this was about as wrong as one could be and the ETF’s dreadful performance reflects that. But these ETFs are extreme instances of the need to take seriously the saying “Past performance does not assure future results.” If you expect a turn in the ongoing crisis, this is the ETF to own (assuming you have the stomach to tolerate adverse leveraged daily moves while waiting for the markets to come around to your view).

FactorShares 2X: Gold Bull/S&P500 Bear (NYSEARCA:FSG): Here’s one that will appeal to many investors today. This fund is bullish on gold and bearish on stocks. Your return would be based on twice the daily difference between gold futures and S&P 500 futures, being long gold and short the stock market. If you think the world, or at least our financial way of life, is coming to an end, this is the ETF to own. Remember to think in terms of spreads. It would, obviously, be best if gold rose and stocks fell. But it doesn’t have to happen that way. You’d be OK if gold and stocks both rose, so long as gold rose more briskly. It would also be OK if both were to fall, so long as the stock decline was sharper.

FactorShares 2X: S&P500 Bull/USD Bear (NYSEARCA:FSU): This ETF tales a long position in the S&P 500 and a short position in the Dollar (the return specifically is based on the two times the difference between the daily returns of the relevant futures contracts). It would be a nice ETF to own if you think a lower Dollar will enhance the competitiveness of U.S. businesses leading to increases in profits and stock prices. You’d likely be coping with higher interest rates too, but if rates are rising for the “right” reasons (a strong economy), that could be OK, so long as rate increases don’t become excessive.

FactorShares 2X: Oil Bull/S&P500 Bear (NYSEARCA:FOL): This is the ETF to own if you think rising oil prices are going to push the economy and stock market over the edge. (The return is the based on two times the daily difference between oil futures and S&P 500 futures, with the fund long oil and short the stock market). It’s not a slam dunk even if you think we’re going into a new recession. Weaker economic activity can depress oil prices. You’d really be playing the chicken-and-egg dynamic here; assuming high oil pushes the economy down, in which case you’d take your profit and get out before the weak economy turns tail and pulls oil down with it. Again, though, remember we’re dealing with spreads. It’s OK, for example, if oil and stock both fall, so long as the stock market declines are steeper.

I’m not sure if more ETFs like this are on tap, but I think it’s an interesting addition to the investment menu. It allows investors to make simple, direct, plays on broad macro-economic developments. Is it risky? Of course! You’ve got to make the right macro calls, and you have to deal with the leveraged daily returns (although I think by now, with ProShares, Direxion, et al having progressed beyond newbie stage, investors have become accustomed to seeing how this sort of thing works). But I’m not sure the risks are greater than those assumed by investors in many other areas.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.