3 ETFs for Playing Defense in 2022

The market's rocky start to the year surely has some investors thinking about adding protection to their portfolios.

3 ETFs for Playing Defense in 2022

Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. The U.S. stock market has gotten off to a rocky start so far in 2022. Is it time for investors to think about playing a little defense? Joining me today to discuss the topic and to talk about a few defensive ETFs is Ben Johnson. Ben is Morningstar's global director of ETF research.

Hi, Ben. Thanks for being here.

Ben Johnson: Hi, Susan. Thanks for having me.

Dziubinski: So, Ben, can you put into perspective a little bit about what's driving the stock market this year and what's going on? Do you think a little defense might be warranted on the part of investors?

Johnson: Well, Susan, what we've seen thus far in 2022 has been a not-so-gentle reminder that stocks can also go down. We've been living through moments and markets that have been marked by no alarms and no surprises, and what we're seeing is that there's evidence, increasingly, that this bull market is getting quite long in the tooth, very long in the tooth, and that valuations are stretched. Things may or may not be, depending on the corner of the market, priced to perfection. So, any little blemish we see, any little cloud we see on the horizon is enough to send people running for the hills, in some cases. And certainly, in some corners of the market, we've seen that notably in some of the high-flying and profitable growth names that powered markets forward through most of the post-COVID recovery period.

Dziubinski: Ben, of course, one of the issues that investors are concerned about this year is inflation, and one of your picks is actually an inflation-related fund, Vanguard Short-Term Inflation-Protected Securities VTIP, and again, this focuses on shorter-term TIPS. Who might this ETF be a good idea for? What do we like about it?

Johnson: Well, this is a fund that might have the most appeal to those folks that are worried about both inflation and rising rates, given that it directly helps to hedge inflation, investing in Treasury Inflation-Protected Securities, which see their values adjusted based on inflation prints. Also, for those who are worried about rising rates, this focuses exclusively on the shorter end of the maturity spectrum within the TIPS market. So, if you're worried about both of those two scary things, inflation, which has reached its highest level in decades recently, and rising rates, which for years now we've thought that they have really nowhere to go but up, and certainly inflationary pressures would seem to point to them going higher, the Fed has telegraphed that they are going to indeed go higher at some point in the very near future, just how high for how long is anybody's guess. But VTIP is an interesting option for those investors that are worried about both of those things that are looming large in the investment landscape today.

Dziubinski: And another defensive idea is Vanguard Dividend Appreciation VIG. What qualities does this ETF possess that give it sort of that defensive flavor that investors might be looking for?

Johnson: Well, VIG is just a terrific all-weather portfolio. But when it really shines through is oftentimes when the going gets tough. And when the going gets tough, it's those durable franchises that this portfolio tends to fold in that tend to hang tough. So, VIG looks for durable dividend growers, firms that have paid dividends for at least 10 years running, have grown those dividends for at least 10 years running. And what that is evidence of is a solid franchise, of solid and steady cash flows, of growing cash flows that are going to be able to supersede and cut through whatever choppiness we see in the broader markets. Indeed, that's been the case through the fund's long history. It tends to hold up better than the market at large when the market goes through some of its toughest stretches.

Dziubinski: And then, lastly, Ben, your last idea is iShares MSCI USA Minimum Volatility Factor ETF USMV, which is a low-volatility fund as its name suggests. How does the fund work and how might it play a role in a portfolio that's trying to play a little bit more defense?

Johnson: USMV is ultimately setting out to build the least volatile or at least a less volatile portfolio of stocks drawing from the MSCI USA Index as its starting point. So, the USA as its oyster, it–subject to certain constraints–tries to build the least volatile portfolio it can from that starting point. Now, it's generally done a very good job in meeting its objective. It's been incrementally less volatile than the market at large. But it is incumbent upon investors who are considering this fund to understand that low volatility, less volatility does not mean no volatility. We've seen episodes in this fund's life span where it's been every bit as volatile, sometimes more volatile, experienced sharper drawdowns than the market at large. It is going to be less volatile over a long period of time and should not be either praised or discarded based on its performance in any one episode in the markets. It's also important to understand that the trade-off that is involved here is that you will in all likelihood experience less downside volatility in exchange for capturing less of the upside.

And there was a very poignant and painful reminder of that for investors in this fund, many who have since fled, in the sharp rebound we saw off the market bottom in 2020. What we saw is that USMV and many of its sibling strategies couldn't even come close to keeping up with the market when it made its fastest-ever comeback. And that is a trade-off that you're going to have to be able to make, it's pain that you're going to have to be able to take if you're going to stick with a fund like USMV and use it successfully.

Dziubinski: Ben, thank you so much for your time today, your perspective on the markets and these defensive ideas. We appreciate it.

Johnson: Thank you again for having me, Susan.

Dziubinski: I'm Susan Dziubinski with Morningstar. Thank you for tuning in.

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