Bear markets, recessions, and market downturns are largely unpredictable by their very nature. Here we’ll look at the best defensive ETFs to weather the storms and survive or even thrive during periods of market turmoil in 2023.
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Introduction – Being Defensive During Bear Markets
Attempting to time the market – predicting bear markets and recessions – is usually more harmful than helpful. What we can do, however, is prepare ahead of time by assembling a diversified, defensive portfolio of different assets, geographies, and equity styles.
The key to portfolio diversification is in holding uncorrelated assets. For example, when stocks go down, bonds tend to go up. Diversification seems to be the only free lunch in the market in that sense. Diversification is particularly important for investors with a short time horizon or low risk tolerance.
Warren Buffett’s #1 rule is “Never lose money.” Mitigating drawdowns preserves capital. Black swan events and even extended bear markets and recessions are largely unpredictable, but there’s no reason to simply withdraw to cash out of fear. The defensive ETFs below help increase portfolio diversification and provide downside protection so that risk-averse investors can have peace of mind during periods of market turmoil.
Historically, there have been specific defensive asset types and sectors that are more resilient to bear markets and recessions, some of which are colloquially referred to as “crash-proof.”
Below we’ll explore the best defensive ETFs to capture these assets.
The 7 Best ETFs for Bear Markets and Recessions
Below are the 7 best defensive ETFs to stave off drawdowns.
FUTY – Fidelity MSCI Utilities Index ETF
Demand for utilities like water and electricity stays relatively constant during recessions and bear markets. These services are usually the last expense consumers cut. Consequently, utilities rarely experience drops in revenues, and are thus considered defensive stocks. The sector is also popular for providing consistent and high dividends.
The Fidelity MSCI Utilities Index ETF (FUTY) seeks to track the MSCI USA IMI Utilities Index and has an expense ratio of 0.08%.
VDC – Vanguard Consumer Staples ETF
Similarly, demand for consumer staples – everyday products that people need like dish soap, deodorant, toothpaste, food, beverages, etc. – is non-cyclical and doesn’t change much during economic downturns, as consumers are unwilling or unable to stop buying these products. Thus, consumer staples stocks like Johnson & Johnson and Procter & Gamble tend to weather storms well and are considered to be “defensive” stocks. These stocks also usually maintain a consistent dividend payment during recessions and bear markets. Like utilities, consumer staples have the added benefit of being lowly correlated with the broader market.
The Vanguard Consumer Staples ETF (VDC) has over $6 billion in assets and over 90 holdings across the U.S. consumer staples sector. The fund seeks to track the MSCI US Investable Market Consumer Staples 25/50 Index and has an expense ratio of 0.10%.
VGIT – Vanguard Intermediate-Term Treasury ETF
Treasury bonds offer the lowest correlation to stocks of any asset type, and are considered a flight to safety asset since they’re backed by the U.S. government. Treasury bonds are the go-to diversifier to add downside protection and volatility reduction in a diversified investment portfolio alongside stocks. The popular 60/40 Portfolio shows how well this relationship has worked for decades. When stocks go down, bonds tend to go up. This relationship is conveniently amplified during market downturns and periods of high volatility, during which investors usually flock to treasury bonds for safety.
The Vanguard Intermediate-Term Treasury ETF (VGIT) roughly matches the average maturity of the total U.S. treasury bond market, and is a one-size-fits-all bond duration between short and long, suitable for any investor. This ETF has over $10 billion in assets and a low expense ratio of only 0.05%.
SGOL – Aberdeen Standard Physical Gold Shares ETF
Commodities are also considered a safe asset during market turmoil, the most popular of which is gold. The shiny metal acts as a store of value and performs well when the value of fiat currency is on the decline. Uncertainty in the market and/or falling stocks usually have investors running to gold, at least for a small part of their portfolios. Gold has a special diversification benefit of being uncorrelated to both stocks and bonds.
The Aberdeen Standard Physical Gold Shares ETF (SGOL) is physically backed by gold bullion. This ETF tracks the spot price of gold bullion and is the most affordable gold fund out there with an expense ratio of 0.17%.
TAIL – Cambria Tail Risk ETF
TAIL from Cambria rolls slightly out-of-the-money (OTM) put options on the S&P 500, which are basically an insurance policy that pays out in a major crash. The fund holds mostly intermediate nominal and real treasury bonds to help pay for the premiums of the small allocation of put options. I mentioned it when discussing tail risk here.
I don’t want to get too in the weeds on options specifics, but OTM options are cheaper and possess greater convexity. But because of this, we would only expect them to pay out big in a severe crash, not necessarily in a minor market dip.
TAIL has a little over $400 million in assets and a fee of 0.59%.
USMV – iShares Edge MSCI Min Vol USA ETF
Speaking of low volatility, we can specifically target that factor with a popular fund from iShares: the iShares Edge MSCI Min Vol USA ETF (USMV). Funds like this allow investors to stay in stocks while reducing portfolio risk and minimizing drawdowns during bear markets and recessions. This fund finds stocks in the market that exhibit low volatility, ranks them, and then also looks at their expected future volatility before deciding whether or not they make the cut.
This ETF has over $34 billion in assets and an expense ratio of 0.15%.
SH – ProShares Short S&P 500
True bears may simply prefer to directly “short,” or bet against, the market. This can be done with inverse ETFs. These products use swaps and debt to provide the opposite return of the underlying index. In this case, if the index drops by $1, your position increases by $1.
The ProShares Short S&P 500 (SH) provides the inverse return of the S&P 500 Index. The fund has nearly $3 billion in assets and an expense ratio of 0.89%.
Where To Buy These Defensive ETFs for Bear Markets
All these defensive ETFs should be available at any major broker. My choice is M1 Finance. M1 has zero trade commissions and zero account fees, and offers fractional shares, dynamic rebalancing, intuitive pie visualization, and a sleek, user-friendly interface and mobile app. I wrote a comprehensive review of M1 Finance here.
Disclaimer: While I love diving into investing-related data and playing around with backtests, I am in no way a certified expert. I have no formal financial education. I am not a financial advisor, portfolio manager, or accountant. This is not financial advice, investing advice, or tax advice. The information on this website is for informational and recreational purposes only. Investment products discussed (ETFs, mutual funds, etc.) are for illustrative purposes only. It is not a recommendation to buy, sell, or otherwise transact in any of the products mentioned. Do your own due diligence. Past performance does not guarantee future returns. Read my lengthier disclaimer here.
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