MW These ETFs protect against 'black swan' stock-market events like we've just seen

By Mark Hulbert

Sophisticated strategies take an unconventional approach to risk management

Insuring your portfolio against a "black swan" event in the financial markets isn't as easy as you'd think.

Black-swans events are rare - hence the name - but when they happen they are sudden, awful and unpredictable. The U.S. stock market's double-digit percentage loss over the past three trading sessions presumably qualifies.

Most of us think that the same risk-reduction strategies we employ in "normal" times will also protect us from black swans. We believe it's possible to dial portfolio risk up or down, depending on our tolerance. For example, we think that by pursuing a not-too-risky, not-too-conservative strategy, we can still enjoy the bulk of the market's upside while also being protected from its black swans.

Risk analyst and author Nassim Nicholas Taleb, in his 2007 book "The Black Swan," argued that this belief is mistaken, since "middle-of-the-road risks" are not related in any straightforward way to the risks at the tails (extremes) of the distribution. A man whose feet is in the oven and head in the freezer is not OK, no matter what his average body temperature would lead you to believe.

Take the traditional approach to risk management, the 60/40 stock/bond portfolio. Over the three U.S. trading sessions through Monday, it produced a 6.9% loss (assuming the stock portion was invested in the S&P 500 SPX and the bond portion in long-term Treasurys).

In contrast to traditional risk-management approaches, Taleb recommended what he called a "barbell" strategy: "Your strategy is to be as hyperconservative and hyperaggressive as you can be, instead of being mildly aggressive or conservative." One barbell strategy is to allocate the bulk of your portfolio to Treasurys and invest the interest you earn from these U.S. government bonds in S&P 500 call options.

To be sure, this strategy will still experience some short-term volatility. But because you're only investing the interest you earn, you won't lose money with this approach so long as you hold the Treasurys until maturity. And, depending on the options you purchase and the behavior of the S&P 500 SPX, you will participate in much of the market's upside.

Exchange-traded-fund providers now offer ways for individuals to employ these sophisticated game plans. One that employs a variant of Taleb's strategy is the Amplify BlackSwan Growth & Treasury Core ETF SWAN, which invests 90% in U.S. Treasurys and 10% in S&P call options. Though this ETF was created in late 2018, the index to which the ETF is benchmarked has been calculated back to December 2005. Over that backtested time it has produced a 6.8% annualized return, versus 8.4% for the S&P 500.

In other words, the historical "premium" for this black-swan insurance has been 1.6 annualized percentage points. Given the fear and anxiety of the past few sessions, you may decide that this is a fair price.

Another barbell approach is to invest most of your portfolio in a stock index fund and allocate a small portion to S&P 500 put options. One ETF that pursues a variant of this approach is the Swan Hedged Equity US Large Cap ETF HEGD. This ETF's issuer reports performance back to 1997 for managed accounts that pursued a substantially similar strategy to that of the ETF (which was launched in late 2020). From mid-1997 through the end of 2024 this strategy lagged the S&P 500 by a margin of 7.5% annualized to 9.1%. That implies an insurance premium of 1.6 annualized percentage points, nearly identical to that of Amplify's ETF offering.

The bottom line? Black swans are unavoidable. And because they also are unpredictable, insuring against them can't rely on the fantasy we'll be able to anticipate when one is about to occur. Answer honestly: Before April 3, did you have any idea what would ensue over the next three sessions?

Protection against black swans depends on insurance policies we have in place through thick and thin. Homeowners don't let home-insurance policies lapse. Nor should you for any black-swan insurance you buy.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com

Also read:

As the S&P 500 crashes, this new retiree says advisers are 'head-in-the-sand clueless'

How to protect your money during today's economic uncertainty

-Mark Hulbert

This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.

(END) Dow Jones Newswires

April 08, 2025 09:03 ET (13:03 GMT)

Copyright (c) 2025 Dow Jones & Company, Inc.