Protection against black swans: Which ETFs investors can use to protect themselves

• Black swans occur suddenly and unpredictably
• Hedging against them must therefore always be part of the portfolio
• Special ETFs offer some protection, but are associated with hedging premiums

The term “black swan” was coined in 2007 by risk analyst Nassim Nicholas Taleb in his book of the same name. This refers to rare, unpredictable events with massive impacts on society, the economy and Financial markets. Precisely because black swans seem so unlikely and rare, the risk they pose is often ignored by investors – until they suddenly occur and cause significant losses. According to MarketWatch, black swans are unpredictable but ultimately inevitable. When protecting yourself against them, you cannot rely on the illusion that you will notice them in time. In addition, classic strategies for minimizing risk often do not work for them. Protection against black swans therefore depends on the hedging strategies that are always in effect, emphasizes “MarketWatch”.

In practice, this means: Conventional strategies such as the classic 60/40 portfolio, which consists of 60 percent stocks and 40 percent bonds, do not offer reliable protection against black swans. Because they are not too risky and not too conservative, they only serve to protect against risks in the “medium range”, but not against extreme risks, i.e. those with very bad consequences but low probability. “MarketWatch” provides a fitting analogy: “A man with his feet in the oven and his head in the freezer is not doing well, no matter what his average body temperature suggests.” That’s exactly why a different approach is needed when it comes to protecting against black swans.

Dumbbell strategy to protect against black swans: Protect specifically with special ETFs

To protect against black swans, Taleb recommended the so-called “barbell strategy”. It consists of investing in both as low-risk and as high-risk investments as possible. However, investments with medium risk should be avoided.

According to “MarketWatch”, when implementing a dumbbell strategy, for example, a very large part of the portfolio could be invested in safe US government bonds. The interest generated would, however, flow into risky but potentially very high-return instruments such as call options on the S&P 500, which would then make up a significantly smaller part of the portfolio. If investors hold the bonds until maturity, they will at least get back the amount originally invested, while at the same time they have the chance of significantly higher profits through the call options.

According to the news portal, it would also be a slightly different dumbbell approach if stock index funds make up a large part of the portfolio and these are then supplemented with put options on the corresponding index. With this approach, possible losses on the stock market would be hedged by the put options.

However, implementing such a strategy can be tedious for private investors. However, there are a few ETFs that take a similar approach. One is the Amplify BlackSwan Growth & Treasury Core ETF. This was launched in November 2018 and invests around 90 percent of its portfolio in US government bonds and 10 percent in call options on the S&P 500. Calculated back to the end of 2005, the ETF achieved an annualized return of 6.8 percent, according to “MarketWatch” – compared to 8.4 percent for the S&P 500, although with significantly lower volatility.

Another ETF that relies on a version of the dumbbell strategy is the Swan Hedged Equity US Large Cap ETF. Here, the majority of the capital flows into a broadly diversified stock index fund, while a small portion is invested in put options on the S&P 500. From mid-1997 to the end of 2024, the average annual return here – calculated back from the launch date at the end of 2020 – was 7.5 percent according to “MarketWatch” – compared to 9.1 percent for the S&P 500. Investors must therefore accept a hedging premium in any case.

Tail risk ETFs provide protection against extremes

According to “Bloomberg”, tail risk strategies also offer another option for hedging against black swans. These focus on protecting against extreme events at the end of the statistical distribution – precisely those triggered by black swans. According to the news site, funds such as the Cambria Tail Risk ETF and the Alpha Architect Tail Risk ETF experienced a strong comeback in early April amid the back and forth over US tariffs and the associated stock market tremors. Both rely on staggered, protective put options on the S&P 500 to protect against falls.

Although these strategies often do not pay off in calm market phases, as they typically deliver lower returns, they can generate massive profits in the event of a sudden crash – exactly when classic portfolios stumble. In this sense, both the black swan ETFs and the tail risk ETFs mentioned act like insurance against the unexpected.

Editorial team finanzen.net