Hedging With ETFs Is Trickier Than It Looks

some red. Sometimes you also still see some green. But what the red reminded people is that there isn't something that you can do as an investor that can protect you a little bit. Yeah, as an analyst in E t F an else, I'm asked a lot by people who just know me as the E t F guy. Hey, how can I hedge the market? Or how can I actually like put money in something that would go uphen the market goes down. This is a popular question that I got even before the drawdout. I get this question

quite a bit. So I recently wrote a primer on how to hedge your portfolio with E t F s and got a lot of reads. So what we're actually gonna be spending this episode talking about is hedging. And because Eric and I don't actually manage money or give investment advice or give investment advice. We're bringing in someone who can do both. Mike Venudo at Toroso Investments, where he's the co founder and c I O, and he knows this stuff backwards and forwards. And Mike just I've

met Mike several times on the circuit. As I like to say, that's for Todd, Rose and Bluth and I hang out. Mike is I thought that was the hot tub that's come on. That was an awfor discussion. Mike is what I considered to be an E t F sort of Jedi master. He isn't all E t F using advisor. There's people like this around that are so good. They sniffed through the whole toolbox and so they're great that I interview these people from my book and they were very good because you could throw any ticker at

them and they have an opinion on it. But not only that, they have an opinion on it because they have money on the line. So there are really a twofer in terms of commenting on this kind of stuff. And to be clear, some of the stuff that we're gonna talk about is going to be a little bit more technical then most people might be accustomed to. But we're gonna try and keep it really simple. And to go back to that, you know, the Walmart superstore that

Eric's the manager of. Maybe maybe this is when you when you get to the home depot on Saturday, instead of getting the you know, the normal shopping cart, you get the other kind that's a little bit more heavy duty, the flat one with with still with the broken wheels that go. But but this is the best version of

the broken wheel, so good for you on that. And the other thing is, yes, this is and when you talk about that aisle where you need that cart, normally that's the place where you have to ask the guy from Home Depot like what's up because you don't know what you're doing. So I think that's a good metaphor for this. And also not all of the ETFs we're gonna go over today are are that hard to understand.

But the first ones will be where we decided to start with the really hardcore exotic stuff that's been in the news lately, and then we're gonna kind of like slowly go to the more safe plane vanilla stuff that most people using their portfolio. So keep in mind we're going from like if this were a music store, We're gonna start with n W A and then we'll end with the parts family. On this episode of trial, how to hedge a portfolio? Okay, Mike, how did you find

the E t F and what was that first trade? Like? I found ets because I saw it as a disruption to buying individual stocks, which is what we did at Horizon Kinetics, where where I learned about investing. The first trade ever we did into an e t F was buying t I P, which is a Treasury inflation protected U e t F, and we sold calls off of it. I think we're gonna get into some of that type of thing later. And we did it because it was a way to diversify away and protect or hedge the

rest of our portfolio. And this was not that long ago two eight so that was what you did. What do you do now? So four or five years later, I guess it was two thousand twelve, I started to Rosto Investments. The core idea was to have an E t F research company and use that E t F research for a primary portfolio that's based on protection. We use the acid algy Sha model of the permanent portfolio and we fill it in with intelligent et F choices.

So I spend my time researching tickers and talking to people like Eric Um all day, all night, and we have to do it for a little while. Uh, So talk about who your clients are. Sure, So we have two types of clients. We have an individuals who come to us and want advice on which ETF to own, whether it's for our asset allocation models or something they're trying to do. Then we deal on the other end

with the institutions. And the institutions are two parts, people who want to use ETFs, people who are issuing e t F s, and through our we call our e t F think tank, we connect both and enjoy the conversation. Okay, let's go ahead and talk about hedging. Then, Eric and your primary you talk about vix VIX. Uh this is a very controversial, highly dangerous area. The VIX is an index that measures volatility on options, as known as the

fear did right. So if it starts moving a lot, it means people are taking out insurance on their portfolios, which is what they do with options. So if the VIX goes up, it means people are buying insurance, and that means volatility as a foot. So the VIX goes up when people are nervous. Now, there's no et F that tracks the VIX. It's a calculation, it's not a real thing. But there are futures on the VIX. So the e t F s and e t n s track those futures. And these are the bad boys. These

are totally the bad boys. Because red lights, oh red lights, but with a score of about ten or thirteen. So there's the n C seventeen on my stop lights system easily. So why people love them even though they lose money year after year and like all of them are down about nine since launching. The reason people love them is jackpot potential because when the market goes down, nothing will come close to the what you get with the VXX

or that kind of return. So for example, you look at something like in August, market was down four percent that day v XX was up. Now that's way beyond even a triple leverage in verse SNP. Then you go to a bad month market down eight percent, VIX is up or VXX rather, and then two thou eight when the market was sound thirty eight percent, v XX wasn't around, but the index at tracks was up a d so that jackpot potential is what draws people like a shiny object.

The problem is a lot of people if they get too close and hang out there, they lose a lot of money because you have to roll those futures and that can cost you thirty percent a year. So it is an expensive hedge and you could lose a lot of money. But the reason it sticks around and has an audience is because it can pay off big time. Sounds a little bit like when you go fishing and you use that really fancy lure, you know that catches

all the light in the water. That's what this sounds like a little bit, right, Yeah, you gotta be careful because you get like might get caught. Absolutely, Yeah, don't take the bait is probably the best advice for almost all investors, except for people who really know what they're doing. And Mike, so, how have you guys been talking about this with clients? So using the VIX is extremely complicated. I totally agree that it is nc SEV, maybe even triple X. I don't even know if they use those

any work. But the biggest issue with VXX or T VIX or any of these. Isn't just that you have to know how much you want to hedge. You have to know exactly when, like when to the precise second day, because the decay the cost of this insurance is enormous. And I don't know that, do you know? Do you know that you know when? I don't believe anybody can really know when. I'm sure there are some tactical people out there who think they do. But yeah, look, I mean this is why I use Biff from Back to

the Future too. Remember how we got the Guide to the Sports and he and he got he was like the richest guy in the country because he knew the future. Unless you have the guide to what the vix is going to do in the future and your Biff, nobody knows. And I think that's you know, that is Timing is

everything with the vix UH and VXX. But like I said, if you have some special insight into the future, or if you really, really really just think tomorrow is going to be horrendous, there's really no problem with holding it for a day. It wouldn't corrode that much in one day. You gotta get out quick. Can you say all what you just said in Biff's voice, come on, McFly, you should say it. Come on, he's the Michael Winslow of the two of us. Okay, so there's another bad boy,

maybe on par with Biff inverse. Yeah, So inverse is that's basically saying we're going to short the SP five hundred, either using swaps or futures, and so if the SMP five hundred goes down, say two percent, they should go up to. Then they've got double leveraged short and triple leveraged like a hoverboard. Yeah, but s h is the one I think is interesting because Eric didn't take that bait. Oh sorry, I put the hoverboard out there and you didn't jump on it. That was now I can't even

touch that. That's just untouchable owning. This one is like when Biff runs into the manure truck and yeah, it can be run pretty short and stinky. Look, Okay. The one I think is interesting, and I'd like to get Mike's opinion on sh this is inverse SMP five. You

have to reset the short position. So there is a volatility drag that and we won't go into the details here, just know that there is there is a corrosion to it's a costly hedge as well, but nowhere near v x x, and essentially if the market goes down to percent, this will go up to Curious what you think whether this is viable? You could you could hold this a little longer without that extreme decay of v xx or would you also put this in don't touch it ever? So with v x x, it's all about timing. You

have to get the time right with this. With s H, it's not just timing. It's a little less important here, but it's also about the direction of the market. So it's not just down, but is it volatile down? So this reset that you're describing that can cause it to decay is rapidly as v x X. So now you've added yet another element that you've got to get right.

And the reset is just to break this down. For anyone out there is leverage ets or inverse ETFs, they have to reset their leverage every day so they account for the new people coming in. You can't do two times from like two years ago, and you have to reset it every day there for people coming in and out. It makes sense, but when you reset at prices that are going all over the place all that it just creates a like a Matthew kind of corrosion because you're

resetting all. If it goes up a similar direction, you start resetting higher and higher, and you actually compound a little bit. So you have volatility drag in almost all cases, which can corrode this insurance. But every now and then, if it does go up straight, you get the compounding effect,

which can help. So I think you're right. If you have a feeling the market could go down steadily over the next year, s H would make a lot of sense, right, Yes, But as we saw recently, we have one day down at thousand points, one day up at thousand points, one day down thousand points. That is terrible for something like SH. You actually could still lose money even though you're inverse. Tactically, why would someone use this and and how much would they?

You know, dial up the volume with it. So people who understand tactical or believe they figured it out, they use this all day long. UM. They may be hedge funds, they may be et F strategists. I mean good Harbor in the old days was known for this. UM. This is not for your average investor to make a strategic allocation. This is the difference between owning something, buying hold and trying to guess when something's going to happen and react. You can't simply buy this and then go to work

unless you want to lose your hands. This trades to change saw. It's a change saw. You better be careful. And you know there are people who are like say, like bitcoin investors, people who just love gambling and speculating. Those kind of retail investors are attracted this, but you they are. They're messaging each other on Reddit and they're informed that you can't hold it. What you don't want is somebody who is retail a or even institutional and

just doesn't understand that and is sticks and it. You can tell from the trading volume of these like these leverage gtfs and vix ETFs trade about fift their assets every day. That is a humongous turnover. That means they are being used correctly. As hot potatoes. Five six years ago, I think you saw less volume because people were unsure

how to use them. But there's a lot of teachable moments since then, so I do think they're probably mostly in the right hands, but they definitely should be labeled just like the vixed products. The labels are all over them, right. If you notice all of these, even in their their name, it says daily like they they have gone out of their way to warn the public. We have created the sharpest knives. And unless you've completed Wolfgang's Pucks TV show

or something, don't pick this up. Just like we've been hearing recently. If you're gonna own the vixed products, read every line of of the prospectus with the leverage and inverse it says it in the name, right, I don't think it could be more black and white than night. Okay, So that was the advanced section, hyper advanced. Maybe let's go to that sort of the intermediate territory because put options,

for instance, this becomes much more common. Yeah, writing options on your portfolio or buying them is a popular method. If you look at E t F, the E t F s out there have options on them that you know you could trade or buy or sell, and most of those options are in the top ten e t fs, like Spy is basically like half the equity market in option violence, it's a monster. I W M E M and that's a big fertile market. People trade those things and do actual tactical moves. But there are people buying

any options for insurance. So a put option would be a way to ensure your portfolio. But again you have to pay for it, and you have it expires, so you'll have to think about Okay, it's expiring, it got to buy another one, and that that affects its price. Yeah, so that is also away again just because now we're dealing with derivatives. I put in the intermediate, but it's not nearly as wild as say the vix or inverse world.

And this one is well, you have to get the timing right, but you don't have to commit so much. You daily, daily at a time. Yes, and and the decay of the cost or the actual cost you're gonna put in, you know from day one. Give an example of buying an option like on on s p Y,

Like what just take us through that trade. So let's say you think SPY is going to decline, you simply would purchase a put at ten percent below or at the money that that all can get very complicated, but ten percent below it's trading in a hundred today, you would buy it. You would buy a put for ninety buy a put for nine because that would be cheaper. Meaning if the SMP goes down what to then you

can then guarantee to sell it to that person for nine. Yes, but in the interim, if it moves down at all, the put option would start to move. So it's not that you can be completely hands off with this, but it's a little bit more hands off and you can go the other way, which is called a call. Yes you could. But even more interesting, what et s beautifully do for all of us is they'll take strategies like this and stick it in the wrapper so you don't

have to go and do this. So there's by right strategies, there's put right strategies. Um, there's one now that buys treasuries I think it's tail, and then uses the income from those treasuries to buy puts on the SMP. What's a classic one that does what we just the scenario where you're protecting the downside with options inside and ETF what's a good example. Um, I think that tail one that I was just describing is probably the purest example of that, but there's plenty of others that have used

options over the years to mitigate volatility. So um, the PDP is a great example. To put right is another great example, p U t W. And then there's funds of option writing funds. So I like this one. Why why why? It's an income fund that's a great ticker yield yield yield. It might be Eric's boy band had when he was in high school. I like that. But all it is is it's a bunch of closes. Inever why y y? It sounds like frosted tip, Eric Bolton. I did use a lot of gel in high school.

I'll admit it. I was all over the depth gel. Yeah. That was my jam. That was like a firm hold. Yeah. Anyway, okay, So put options is one that's sort of the intermediate. Let's let's talk about the alternative space because we're talking about rappers here. Uh, there's a lot of hedge fund strategies that have been wrapped up in in the E T F rapper as well. I can talk about that because that's also sort of an intermediate place. Sure, so um,

hedge funds are misunderstood. Most people think they're trying to babe ruth the performance and get like return every year. Like Christian Bale on the big short. There are some to do that those are up section, but most of them do what the name says, they hedge. They are trying to find some kind of weird obscure risk premium in the market somewhere, capture it and eliminate market volatility to serve up a low vall risk adjust to return. That's actually it's sometimes some of them are voltile is

a bond fund, right, They're very misunderstood. So a lot of the alternatives in that have been wrapped the hedge funds strikes have been wrapped up into et fs. Do that they do merger are their long short, they do managed futures um so it is very complicated area. That's the downside of this. Well, they can do some things that hedge funds do for a lot less than hedge funds charge, so they've democratized hedge fund investing. But they're

very complicated. But what they do is they produce a return stream that is not correlated to stocks and bonds, hence alternative. And the reason they're called liquid alternatives is because only hedge funds which have lock ups, which means for multiple years you might be locked out of getting your money back. Correct so ultimately, alternatives is a category that's pretty broad. Hedge funds is one of example of

an alternative. But by the way, none of us are going to be able to well, at least the three of us are probably gonna be able to put much money on a hedge fund, which here with the EF. Yeah, I'm I'm still a thousand are Yeah, So I would never qualify for any hedge fund, but the HF, nor would you probably be able to pay for it, which is do you know what I want to go into one?

To be honest with you, Um, I'm fine. Look the minds of JP Morgan, Index I Q Goldman Sacks, they've made hedge fund ETFs using actual their brains and doing hedge fund strategies. You can get anything that hedge fund does except for the special star manager, I mean that will always exist, but the general strategies are ETFs. This category is pretty small though, only about two three billion in assets. Um, Mike, do you use any of these? Absolutely? These are the things that I think ets are made

for democratizing access to things. So I've been saying for years that hedge funds will just become a call it kindergarten for e T s right. It's where people will grow up ideas um And it's funny because it's kind of what's happened with a lot of these things like leverage and and using volatility in terms of alternatives to use to protect the portfolio. I think what JP Morgan is doing right now to bring out some traditional hedge

fund strategies in rappers that are more efficient. The one I have loved forever and you've heard me talk about it on your other show, B T A. L Boy, Thomas Apple, Larry. All this does is it's longfty low risk stocks in the SMP all short the two fifty high risk or high beta. The net result is when the markets go down, this goes up. When the markets go up, it goes down half as much as they've gone up. So you miss out on a little bit

of everything. Yes, but with the things we talked about in the first section, the vix and the shorts, there one the one ratios right, you're gonna on the upside, you're gonna lose as much as you're gonna make on the downside. With something like this, the reason it's more strategic and can be held longer is when the markets are growing up, you're really only paying fifty cents for that dollars worth of protection. Now betal in our system does get a yellow Oh yeah, I'm sure it does.

It's complicated, it's alternative, and but really it's because when you short anything, there is a cost to that. So there's a there is a slate head when in that cost and show up the expense ratio. But you find that appropriate. Not you would pay it anyway if you did it yourself. But what does that cost? Like in betel so something like beatle, because half the portfolio is short,

that has a cost to borrow. To short something, you have to borrow the stocks um and that gets passed onto the end investor and it offsets whatever dividends you would be getting from the other side. So the the expense ratios that you'll see in a system will look a little expensive. That said, for a hedge that you can actually buy and hold, I like the concept. Okay, now we're gonna get in a safe the safe zone. And this hedge is one that everyone is actually familiar with.

Gold gold they're familiar with it, but boys are controversial. It's like politics. There's gold bugs and there's gold haters who are offended by the mere concept of gold. They say it's just the rock and they don't like it. So I know that it's get heated. So gold though. The pro of using gold as a hedge, something like g l D, which is the biggest gold, is that it isn't correlated to the market at all. It's zero correlation. No one knows why it does what it does. Correct,

that's the problem. It's also zero correlated, meaning if the market goes down, gold may or may not go up. It's sort of like a punk rock or it does whatever the hell it wants to do, but that's its beauty. You have to appreciate that it's a good diversifier, but not a it's a shaky hedge. You do like the remoons too? Huh? Yeah, I thought I was a little I was a little more of a social distortion kind of guy. Yeah, so, but the remains that you can't not like, are you a punk rock fan? Mike? Uh no,

you guys were talking about high school earlier. I was the debate champion, chess champion with long hair following the Grateful Dead, So I'm definitely are you a gold bug or a gold I am definitely a gold bug totally have built my acid allocation model on the permanent portfolio, which is gold. Now that said, that doesn't mean you just buy g l D or B A R I AU. There are smart ways to add to own gold like

um you know. To loop back to the other section where we talked about options, one of the things I love using is a little E T N called g l D I A right so I own gold. It sells calls on that gold, which gives me income off my gold while I'm waiting for my gold to do what we hope it will do. Moving to the mainstream gold ETF So you've got g l D S forty

basis points I use. Then you've got these ones that are for like hardcore paranoid gold people like one stores it in Switzerland s g o L, and then one will deliver you physical coins O U n Z. Where do you stand? Do you think that the US would ever confiscate gold? Like? Are you it has right? The FDR did it? There are people s g O L has a billion dollars just because it stores the golden Switzerland, whereas g l D and I used store in the States.

In Canada, so I understand that extreme of the gold bugs, and I wish them the best. I'm quite happy with an I A U or g l D A B A r B because in the scenario where getting that physical gold matters, I don't think it matters that you own an ETF that claims to have the physical gold. Yeah. I mean, look, gold has been around. It survived many civilizations,

let alone generations, so I I respect it. I'm more agnostic, and I do think it isn't it's extra shaky as inflation hedge, but I have seen it work as a crisis hedge. But in two thousand and eight, for example, the market was doundt g l D was only up three So again it it didn't go down, but it could have gone down. It could have gone up. Who knows? Who are these people? I'm just in my Jerry Seinfeld emerged into Seinfeld. Sometimes I slowly get there and then

I end up with who are these people? Um? Just to add on with gold one other thing, it gets a green lightner system, but it does get a tag with with A one. It has one infraction, which is alternative tax treatment. If you buy g l D or AU you get tax as if you want a collectible. And I think that's just something to point out here, and that's just one little tiny thing that does mar the buying of gold in terms of it being like plain vanilla. So the green light hedge's treasuries. Yes, so

this is what I call the organic aisle. This is known unnatural preservatives, no chemicals. Treasuries are classic and they're big. They've got billions of dollars in assets. People use them all the time. Now, the question is where on the curve right do you buy your treasury E t F. Like, for example, t L T is a treasury E t F. So the pro is it tends to spike up in a crisis because there's a flight to safety. In two thousand eight, t LT was up the exact amount more

or less that the market went down. It would have completely offset your market losses. However, if rates are going up, t LT is going to be hit the hardest. So there's an interest rate component that makes t LT sensitive. Then you start going down the curve till you get to stuff that's closer to quote cash. That stuff will buffer and it won't move, and it's it's consistency. It's sort of like going under a mattress. So the pro is it won't go down, but the con is it

go up either. So there's even a risk to the organic treasuries depending on where you go on the curve. Mike, do stuff stuff under your mattress using treasuries absolutely? Um In in the short term space, I do use things like an s h V, which is a very ultra short term treasury index, right, so you're basically buying cash instruments um in an e T F rappers so you get a little bit more than cash out of it. Is SHV the same thing as a money market fund?

Because I know some people probably use those. What's the difference? And can you replace some money market fund with an sh V? No, they are not the same thing. They are very very very close, but you don't have that guarantee of the dollar staying the exact same price. But the amount of risk you're taking to get a little bit more reward is probably worth it. What's the more reward with sh V A few more basis points are a few more per cents of a percent of yield

um and uh. I do think though, in that space, if you want to stuff money under the mattress. If that's the way you want to protect, which I add resolutely advocate have some money on the side. Some cash cash is good, but you can go to some of the more interesting ones to get a little bit more yield. Like I think First Trust does a great job with f t SM. It's a short term fixed income fun and it's actively managed, especially with these short term things.

I do think active management in fixed income makes a big difference. But before I I get too far down the line on the short term stuff, the long term stuff, the t l t s, those can be painful. Um So you know this year, for example, it's down, It's down a lot. It's down almost six or seven percent over the first couple of months of the year. In two thousand fourteen fifteen, you had moves in these things

that are up in long term treasuries. People get confused by that this is long term treasuries and it can move. It can go the other way as well. I don't want anybody to wake up one day going I thought I had long term treasuries and I lost four that's actually possible. The the the organic part comes from the fact that it's just treasury bills there's nothing else going on in that fun it's a it's a green light zero for us, but I agree, and there's ones to

even go further out in the curve. But I agree that there's a volatility level of deal. How can you give that a green light? Well, because our system is not passing judgment on the user or their motivation. It's just saying, is there anything in this et F the packaging of it that might be a surprise to me? And in the case of treasuries, we're assuming you know that these are twenty plus your treasuries and they have great risk. If you don't know that, maybe our system

will worked out. Well. We're not saying it's gonna go up or down. We're just saying that that's what you're buying. There's nothing, there's no weird action in it, there's no derivatives, there's no hidden costs. It is what it is. Yeah, I would totally agree with the green light on this, but I would caution all your listeners to know when you take bonds and put them into an ETF, you lose one of the most important covenants of a bond, which is a maturity date, a date when you get

your money back. That doesn't happen in in T L T. It is perpetually extending that maturity. And because of that, understand that although you're gonna get returns like a bond, you're not guaranteed to get your money back someday. Okay, bottom line, Mike, how should the average person approach hedging? So bottom line, don't try and time it. Be aware that time in matters way more than timing time in time.

In the longer you're in, the less it matters about hedging. Right, So I love this idea of having some sh V or some cash of some alternative like assets like a g l D or a bar. All of those things matter over the long time, but in the short time, don't freak out. Right, if you have the right plan, everything will be fine. In other words, the ultimate hedge

is patients. I love that. What's your favorite ticker? Well, I have to go with my own, so cheating, Well, it's t t F right, So as E t F T E t F it is the E t F that tracks the growth of the E t F industry. That's the ticker should have been meta, Yeah, you know what, we might change it, so I uh We've talked about the cyril metaphor before. I think and actually this was Eric. I think you are we're all done eating the cereal. You're the milk, the cereal milk at the bottom of

the bowl. I don't know that I ever want to come up with that analogy. Um, you're welcome, But you know it's it's pretty straightforward and simple. We wanted to know all about the ETFs. In order to know about them, you have to know about the industry for creating them. So we created an index and it certainly does a lot better than the financials alone. You know what I like about t e t F not to like plug Mike, but the the stocks at hold. It's like black Rock

States treat the index makers. So here you have an index that's essentially most of the passive companies X the ones that are all in no active and so I think some of that active as the trend continues, could weigh those down. So it's an interesting e t F that I think some people are confused by. They think it's an ETF that holds other e t s, but it actually just it's basically like the passive side of

the financials. And next Mike, it's been a pleasure talking hedging, Biff Manure and Eric's amazing high school jail with you. This has been an experience I won't soon forget. Thank you for having me. I guess that's good time. Yeah, no, Mike had no ideas anymore. Thanks for listening New Trillions until next time. You can find us on the Bloomberg Terminal, Bloomberg dot com, Apple Podcast, pocket Cast, and a bunch of other places I probably haven't heard about yet. We'd

love to hear from you on Twitter. I'm at Joel Webber Show, Eric's at Eric Baltunas, Mike's at Michael Underscore. The Noodoh with an E. Trillions is produced by Magnus Hendrickson. Francesca Levie is the head of Bloomberg podcast Pipe