(By Michael Vodicka) 2012 was looking like a great year to have your portfolio loaded up with stocks. From January to April, the averages were ripping higher, posting their best first quarter since 1998 while pushing many individual names to multi-year highs. But then a little thing called May happened, with stocks sharply reversing course and coughing up a large portion of their annual gains on another big flair up in the Euro zone. It was fresh reminder of just how fragile the global economy remains, with ongoing weakness in the Euro zone, slow domestic jobs growth and disappointing data out of China weighing on confidence.
It was also a reminder of why having defensive ideas and strategies in your portfolio are so important. Carving out a portion of your portfolio for defensive strategies might weigh on your performance profile a bit in a bull market, but on the flip side, it will also work to protect your down side in a weak market. And one of the best ways to trim risk out of your portfolio is by swapping out stocks for bonds. Technically speaking this is called asset allocation, but on a simpler level, it's just a way for investors to position their portfolios for volatility and market weakness.
But with thousands of fixed-income investments to choose from, it's easy to get bogged down. So here is a look at four major categories of fixed-income investments that can help you reduce your downside exposure in a weak market.
Top 4 Fixed-Income ETF's
Technically speaking, the most risk-free asset in the world is a US Treasury Bond, basically used as the benchmark for what is considered "riskless" and used to price all other assets and fixed-income securities. iShares Barclays 20+ Year Treasury BOND (TLT) is an ETF that is linked to an index of Treasury Bonds with a maturity of 20 or more years. With assets of close to $4 billion and average daily volume approaching 10 million, this is one of the most popular Treasury ETF's on the market. It also happens to be fairly cheap, with an expense ratio of just .15% in line with its peers but lower than other category averages. Yields on Treasury's are at record lows right now due to the Fed trying to stimulate the economy, so you won't see a huge dividend, but if you are looking for security and safety, there are few places that the market views as being a better destination.
iShares iBoxx Investment Grade Corporate Bond (LQD) is an ETF linked to an index of investment grade corporate bonds. That means you'll achieve instant diversification with this ETF, representing a total of 891 corporate bonds to help balance your exposure. LQD is also quite popular in its category, with $21 billion in assets and average daily volume of more than 2 million. With an expense ratio of just .15%, LQD is also quite cheap, in line with its peers but once again below other category averages. The conversation gets interesting when talking about yields, with a current yield of more than 4%. In a world where investors are struggling to pick up low low-risk returns, LQD and investment grade corporate bonds in general stand out.
iShares iBoxx High Yield Corporate Bond (HYG) is also a corporate bond ETF, but with a higher risk profile supporting yields, with a current yield of 7.25%. But for investors looking for a higher risk-reward ratio than investment grade corporate debt or Treasury's but with less risk than stocks, this is the place to be. HYG is also a leader in its category, with average daily volume of more than 3.4 million and close to $14 billion of total assets. This is also an index fund, linked to a broad basket of high-yield corporate debt for instant diversification. HYG's expense ratio of .50% is a little higher than what we've seen from other categories, but still lower than most of its peers.
And finally, throwing an international twist into the conversation, we have iShares JP Morgan Emerging Market Bond (EMB), another index linked bond fund to help keep your fixed-income strategy diversified and insulated from volatility. Generally speaking, emerging market bonds will be more volatile than some of the other ideas we have discussed, and you can see that showing up in yields, with a current yield of 4.8%. But beyond market volatility, this is a solid and category leading instrument, with total assets of $4.3 billion and average trading volume of close to 500,000 per day. An expense ratio of .60% is a little higher than some of its competitors, but this is a fairly slim category, so there are fewer names to pick from.
The Take Away
Having a portfolio stuffed full of stocks is a great strategy when the averages are ripping higher. But it can also be quite painful when sentiment shifts and the market turns lower. That's why having defensive strategies in the mix is so important; it will keep you insulated from weakness and volatility. And as you can see, there is no shortage of good name to choose from. Take a look at the chart below to see how each of the previous names has outperformed stocks over the last month in the bearish market.
(click to enlarge)