The Best Hedged ETFs for Lower-Risk Investors and Retirees
For decades, the classic 60/40 portfolio of stocks and bonds was considered the gold standard for balanced investing.
Much of its success, however, coincided with an extraordinary macroeconomic backdrop: a more than 40-year period of generally falling interest rates that began in the early 1980s.
That dynamic made bonds an effective hedge for much of the past four decades. During recessions, central banks typically cut interest rates to stimulate economic activity.
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As stocks declined, bond prices often rallied, allowing balanced portfolio investors to rebalance by selling appreciated bonds and purchasing cheaper equities.
That negative correlation broke down in 2022. To combat the highest inflation in decades, the Fed raised the federal funds rate at one of the fastest paces in modern history. Rising rates caused bond prices to fall sharply at the same time equities entered a bear market.
For many retirees relying on a supposedly diversified 60/40 portfolio, bonds offered far less protection than expected as both major asset classes declined together.
Investors today face the possibility of a higher-for-longer interest rate environment. Inflation remains above the Fed’s long-run 2% objective, while tariffs, fiscal deficits and geopolitical conflict continue to create inflationary pressures that may limit how aggressively central banks can cut rates.
One alternative is to reduce portfolio risk through ETFs that incorporate built-in hedging strategies.
A hedge is simply an investment designed to offset part of another investment’s risk. Like buying insurance, a hedge typically comes with a cost, but in exchange it may reduce losses.
Just like any insurance policy, whether a hedge ultimately proves worthwhile depends on the premiums paid, prevailing market conditions and a measure of luck.
Ultimately, the objective of most hedged ETFs is not necessarily to maximize returns.
It’s to reduce the severity of large drawdowns so investors are more likely to remain invested through periods of market stress, instead of abandoning their long-term investment plan after a sudden decline.
Hedged ETFs are considerably more sophisticated than traditional index funds. So it’s important to understand how the options and other derivatives they employ work.
How do hedged ETFs work?
A hedge is designed to provide ongoing protection for part of your portfolio, helping limit losses when markets fall.
ETFs can employ several different hedging techniques. One of the most common is to purchase put options. A put option gives its buyer the right, but not the obligation, to sell an underlying asset at a predetermined price before expiration.
The underlying asset may be an individual stock or, more commonly for hedged ETFs, a broad market index such as the S&P 500.
Obtaining that protection isn’t free. The buyer must pay an upfront premium. Much like insurance, that payment compensates the seller for assuming downside risk.
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If the market never declines enough for the hedge to become valuable, the option loses value as time passes. This process is known as “theta,” or time decay.
Eventually, the option also expires, requiring the purchase of another put option to maintain protection. As a result, an ongoing hedging program creates a persistent performance drag during strong bull markets.
The trade-off is what happens during a major market decline. Put options can exhibit “convexity,” which means their value doesn’t increase in a straight line.
Instead, gains can accelerate as markets decline further below the strike price. Ideally, this nonlinear payoff allows relatively small premium payments to offset a meaningful portion of large portfolio losses.
Individual investors sometimes purchase puts tactically when they believe markets are particularly vulnerable. Most hedged ETFs maintain protection on an evergreen basis, continuously rolling their option positions as existing contracts approach expiration.
How we picked the best hedged ETFs
First, we narrowed the universe by excluding standalone hedging ETFs, which are designed to be paired with an existing stock portfolio and allow investors to add or remove protection by adjusting a separate allocation.
We also excluded buffer ETFs. These products provide point-to-point downside protection over a predefined outcome period. But they require considerably more timing than many investors realize.
Instead, we focused on evergreen hedged ETFs. These funds can generally be purchased at any time.
They don’t offer the precise point-to-point protection of a buffer ETF. But they do maintain an ongoing downside hedge that continuously cushions portfolio risk without requiring investors to monitor outcome periods or repeatedly reposition their holdings.
Just as importantly, every ETF we selected is an all-in-one solution. Each combines a long portfolio designed to participate in long-term market appreciation with an integrated hedging strategy that seeks to reduce downside risk.
These funds aren’t direct replacements for traditional 60/40 portfolios, but they may serve as useful complements if you’re concerned that stocks and bonds could once again become highly correlated during periods of rising interest rates.
Traditional diversification relies on the expectation that correlations between asset classes remain favorable. Hedged ETFs instead incorporate derivatives whose payoff structures are mathematically defined.
Hedging already creates an inherent performance drag through option premiums, so we established an expense ratio ceiling of 0.55%.
Finally, we required every ETF to have at least $100 million in assets under management.
JPMorgan Hedged Equity Laddered Overlay ETF
(Image credit: Courtesy of JPMorgan)
- Assets under management: $3.9 billion
- Expense ratio: 0.50%
- 30-day SEC yield: 0.5%
The JPMorgan Hedged Equity Laddered Overlay ETF (HELO) is essentially the ETF version of the long-running JPMorgan Hedged Equity Fund Class I (JHEQX).
That mutual fund has attracted attention over the years because of its size. Whenever it adjusts its options positions, the resulting trades are often large enough to be watched by market participants.
According to Morningstar, the strategy has been consistently executed. At its core is an actively managed equity portfolio designed to resemble the S&P 500, paired with what is known as a put spread collar.
Portfolio manager Hamilton Reiner begins by purchasing a put option approximately 5% out of the money on the S&P 500. This establishes downside protection should the market decline.
To reduce the cost of purchasing that protection, the strategy simultaneously sells a second put option approximately 20% out of the money. The premium received helps offset the cost of the purchased put, but it also means investors begin participating in losses again if the market declines beyond roughly 20%.
Finally, to largely finance the remaining cost of the hedge, the strategy sells covered call options typically between 3.5% and 5.5% out of the money. Those call premiums substantially reduce the net cost of the hedge, although they also cap a portion of the portfolio’s upside during strong market rallies.
Each individual options overlay for this strategy is established with roughly three months remaining until expiration. Rather than replacing the entire hedge at once, the ETF resets approximately one-third of its options portfolio each month.
The result is a disciplined options overlay that seeks to reduce downside volatility while sacrificing some upside participation. According to Morningstar, the strategy has historically been effective at lowering risk relative to both the S&P 500 and a traditional 60/40 balanced portfolio.
Choosing HELO instead of JHEQX also makes the strategy far more accessible. Investors no longer need to meet the mutual fund’s $1 million minimum investment requirement, while also benefiting from a slightly lower expense ratio.
Morningstar currently assigns HELO a gold medalist rating, reflecting its highest level of conviction that the fund is positioned to outperform its category peers on a risk-adjusted basis over a full market cycle.
Learn more about HELO at the JPMorgan provider site.
Simplify Hedged Equity ETF
(Image credit: Getty Images)
- Assets under management: $299.9 million
- Expense ratio: 0.43%
- 30-day SEC yield: 0.7%
The Simplify Hedged Equity ETF (HEQT) is a direct competitor to HELO, employing a similar put spread collar strategy to reduce downside risk while maintaining broad equity exposure.
Like HELO, the strategy begins by purchasing a put option approximately 5% out of the money on the S&P 500. It then offsets part of that cost by selling a second put roughly 20% out of the money. The remaining hedge cost is financed by selling covered calls, with the exact strike adjusted dynamically based on market conditions and balancing premium generation against upside retention.
Rather than establishing all of its positions at a single point in time, HEQT ladders the options across three consecutive monthly expirations. This helps reduce timing risk, making the ETF investable throughout the year without investors needing to worry about entering at a particular date.
The underlying equity exposure comes from the iShares Core S&P 500 ETF (IVV), while the hedge itself is constructed using cash-settled European-style S&P 500 options. These options eliminate the possibility of early exercise and can offer favorable tax treatment.
Unlike a typical buffer ETF, which generally derives its exposure almost entirely from options, HEQT physically owns its underlying equity ETF.
As a result, investors continue receiving dividend income from the underlying stock portfolio, contributing to a modest 0.7% 30-day SEC yield.
Learn more about HEQT at the Simplify provider site.
iShares Large Cap Deep Buffer ETF
(Image credit: Pavlo Gonchar/SOPA Images/LightRocket)
- Assets under management: $126.7 million
- Expense ratio: 0.51%
- 30-day SEC yield: 0.7%
The 5%/20% put spread collar is one of the more common hedging structures because it strikes a practical balance between protection and cost.
While an options portfolio can theoretically be constructed using any combination of strike prices, purchasing a put only 5% below the market protects against meaningful corrections without making the hedge prohibitively expensive.
Selling a put 20% below the market generates premium to help finance that protection while still covering the majority of historical market pullbacks, which have generally been shallower than prolonged bear markets.
The covered call completes the strategy by financing much of the remaining hedge cost, albeit in exchange for capping upside participation.
Unsurprisingly, BlackRock’s lineup offers its own implementation through the iShares Large Cap Deep Buffer ETF (IVVB), which competes directly with HELO and HEQT.
The foundation of the portfolio is IVV, providing investors with exposure to the S&P 500. On top of this equity allocation, IVVB deploys a laddered portfolio of FLEX options using the familiar 5%/20% put spread collar structure.
Like HELO and HEQT, IVVB’s options portfolio maturities are staggered and actively managed, allowing portions to be refreshed throughout the year.
This reduces the timing risk associated with entering the strategy immediately before a major options reset.
Learn more about IVVB at the iShares provider site.
Parametric Hedged Equity ETF
(Image credit: Getty Images)
- Assets under management: $140.1 million
- Expense ratio: 0.29%
- 30-day SEC yield: 0.9%
The 5%/20% put spread collar is also popular because it’s systematic and relatively easy to implement. Once established, the strategy can largely run on autopilot as the ETF provider periodically rolls the options.
The trade-off is that it can also be somewhat rigid, as not every market correction unfolds within a 5% to 20% decline. Investors seeking a more dynamic implementation may find the Parametric Hedged Equity ETF (PHEQ) appealing.
According to Parametric, PHEQ features an actively managed portfolio of stocks with less than 70% overlap with the S&P 500 index, while relying on a laddered put spread collar strategy that’s rolled on a quarterly basis.
There are familiar building blocks: a long put financed by selling a lower strike put, with a covered call helping offset the remaining hedge cost. Implementation, however, is more flexible.
The fund maintains four overlapping one-year hedges, with approximately 25% of the options portfolio expiring each quarter. Each hedge is designed to provide roughly a 20% downside protection range from between 10% to 30% below the S&P 500.
The covered call component is also more dynamic. Rather than consistently selling calls at predetermined strike prices, managers adjust the “moneyness” of the covered calls according to prevailing market conditions, giving the strategy potentially better upside capture.
Despite its more hands-on portfolio management, PHEQ is also the least expensive hedged ETF featured in this roundup, charging an expense ratio of just 0.29%.
Learn more about PHEQ at the Parametric provider site.
Fidelity Hedged Equity ETF
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- Assets under management: $915.3 million
- Expense ratio: 0.48%
- 30-day SEC yield: 0.6%
The put spread collar represents a practical compromise between cost and protection. By financing part of a purchased put with a sold put and covered calls, these strategies substantially reduce the ongoing drag associated with buying downside insurance.
The trade-off is that upside becomes capped, and if markets decline far enough, investors begin participating in losses again once the short put moves into the money.
In other words, a put spread collar provides moderate protection against moderate declines in exchange for lower hedging costs.
Investors seeking stronger protection against severe bear markets may find the Fidelity Hedged Equity ETF (FHEQ) to be a compelling alternative. Rather than using a put spread collar, FHEQ employs a much simpler approach.
The majority of the portfolio consists of an actively managed basket of just over 150 stocks with characteristics broadly similar to the Russell 1000 Index and the S&P 500. The hedge is then constructed by purchasing a ladder of out-of-the-money S&P 500 put options with varying strike prices.
Unlike a put spread collar, there are no covered calls sold to finance the hedge and no short puts that reintroduce downside exposure after a certain point. The cost of maintaining the protection is instead paid directly from the portfolio through dividends and available cash.
This creates a different payoff profile. During relatively calm markets or shallow pullbacks, FHEQ’s fully purchased puts may produce greater performance drag than a put spread collar because the fund continuously pays option premiums without offsetting them through option sales.
However, in a prolonged and severe bear market, such as 2008, the strategy has the potential to provide substantially greater convexity.
Since there is no short put limiting the hedge, the value of the purchased puts can continue increasing as markets fall, allowing the downside protection to become progressively more valuable during deep drawdowns.
Learn more about FHEQ at the Fidelity Investments provider site.
