Surprise ETFs Offering Recession Preparation

One of the holdover themes from 2022 that’s appeared with frequency through the first two months of this year is persistent recession forecasting.

Over course, a case can be made that a recession, albeit mild, already occurred because the U.S. economy experienced two consecutive quarters of GDP contraction last year. That’s the standard definition. Unfortunately, politics now affects the endeavor of defining even the most basic of terms. As such, there’s debate regarding what exactly defines recession.

The result of that debate is confusion among ordinary investors and a luxury afforded to economists, who have dubious records of accuracy when it comes to forecasting economic contractions and rebounds. Focusing on retail investors, while fluidity in defining a recession isn’t helpful to these investors, they have options when it comes to recession protection.

Some of those options are, arguably, surprising. Take the case of mid-cap stocks and exchange traded funds – asset classes with surprising amounts of recession buffering. Here are a few mid-cap ETFs to consider and ones that could be sturdy regardless of whether or not an earnest economic contraction materializes.

First Trust Mid Cap Core AlphaDEX Fund (FNX)

The First Trust Mid Cap Core AlphaDEX Fund (FNX) is a relevant mid-cap ETF consideration in any environment, but potentially even more so in a recession due to its unique methodology. While standard mid-cap ETFs are cap-weighted, the $1.03 billion FNX employs a combination of both growth and value factors that act as the foundation for the fund’s basket of 450 stocks.

As research performed by First Trust confirms, mid-caps are fairly durable in the first half of a recession, but the asset class really amplifies its protective powers in the back half of gloomy economic settings.

“Mid-caps had the best returns during 71% of late recession periods, and never had the worst performance,” adds First Trust.

None of FNX’s components exceeds a weight of 0.49% and the consumer discretionary, industrial and financial services sectors combine for about 55% of the fund’s roster.

First Trust SMID Cap Rising Dividend Achievers ETF (SDVY)

Hailing from the same stable as the aforementioned FNX, the First Trust SMID Cap Rising Dividend Achievers ETF (SDVY) offers credible recession protection in its own right by combining the potency of dividends – historically a good recession idea – and mid-caps.

The $1.16 billion SDVY, which turns six years old in November, follows the Nasdaq US Small Mid Cap Rising Dividend Achievers™ Index. While that index sports a tempting dividend yield of 3.01%, its emphasis is payout growth not high dividends. In other words, the qualification for entry into SDVY’s benchmark is established dividend growth and an ability to keep that trend going over the long haul. When accounting for the difficulty in forecasting recession starts and conclusions and the reduced volatility of dividend stocks, SDVY could be an attractive idea during an economic malaise.

“Forecasting the beginning or end of an economic cycle is no easy task,” concludes First Trust.  “For those seeking to position portfolios for a potential downturn, we believe performance tendencies from past US recessions make an intriguing case for mid-cap stocks. Mid-caps offered the best performance less frequently than large-caps during pre- and early recession periods, but never had the worst performance during these intervals, when avoiding losses was critical. Moreover, mid-caps had the best performance most frequently during late recession periods and recessions overall, while never posting the worst relative performance.”

Proshares S&P MidCap 400 Dividend Aristocrats ETF (REGL)

Speaking of mid-cap dividend growth strategies, the Proshares S&P MidCap 400 Dividend Aristocrats ETF (REGL) merits a place in this conversation. This recession-protecting ETF follows the S&P MidCap 400^® Dividend Aristocrats^® Index, which mandates member firms increased payouts for at least 15 straight years – a high watermark for any mid-cap ETF.

As a result of that stringent index requirement, fewer than 50 stocks reside in REGL, but for long-term investors, there could be something to be said for that element of exclusivity.

“Since its inception in 2015, the S&P MidCap 400 Dividend Aristocrats Index has outperformed the broader S&P MidCap 400 by 177 basis points annualized, with lower levels of volatility,” according to ProShares. “The mid-cap Dividend Aristocrats have also demonstrated a history of weathering market turbulence over time. They’ve done so by delivering most of the market’s upside in rising markets with considerably less of the downside in falling ones—a valuable feature in times of uncertainty.”

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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