A Hedge For a Frothy Market?
The stock market has had a nice healthy run since autumn - from the scares of the fiscal cliff to the rebound from mid November. This market as defined by the S&P 500 is up almost 12% from the recent low of 1353 on November 15th. In light of these strong gains, many active investors may now seek some kind of portfolio protection with the looming Washington budget stalemates, signs of a weakening economy, and an overbought market technical picture. In quickly determining an overbought or oversold market, this useful chart illustrates the percentage of S&P 500 stocks trading over their 50 and 200 day moving averages. When things look overbought over an extended period of time some investors may wish to employ a hedge.
The (BTAL) QuantShares U.S. Market Neutral Anti-Beta Fund is a decidedly unique market hedging ETF that commenced trading mid September 2011. The fund tracks before fees and expenses the Dow Jones U.S. Thematic Market Neutral Anti-Beta Index. The index ticker is DJTMNABT.
This Dow Jones thematic index seeks to exploit and deliver the spread return between low beta stocks and high beta stocks. The fund "is equal weighted, dollar neutral, sector neutral and is not levered. The index rebalances monthly by identifying the lowest beta stocks as long positions and highest beta stocks as short positions, of approximately equal dollar amounts, within each sector."
That monthly rebalance is desirable because it can attempt to capture the fickle flavor of the month market darlings and avoid holdings that go stale. According to the fact sheet, the fund is short about 200 holdings with an average beta of 1.87 and long about 200 holdings with an average beta of 0.35. Beta, and especially its close cousin volatility - are becoming quite popular these last few years, with the low and minimum volatility ETFs gaining quick acceptance helped along with some market outperformance.
Spread Returns Explained:
From QuantShares, a detailed explanation of the spread returns and why it can be desirable as a hedge:
"Our market neutral ETFs seek to generate positive returns when after expenses, the basket of approximately 200 names that the fund buys (long positions) outperform the basket of approximately 200 names that we sell (short positions). Our ETFs combine bullish and bearish positions within one ETF. The spread return generated between the buys and sells is what is important, not the absolute return of the market."
The folks at QuantShares also explain about how this strategy will affect the fund's price:
"If the long positions rise more than the short positions the ETFs will generate positive returns. Additionally, if the long positions fall less than the short positions the spread return will be positive. Therefore, regardless of the direction of the overall stock market, up, down or sideways, as long as the long positions outperform the short positions the Fund will have a positive return. Alternatively, the fund will have a negative return when the long positions underperform the short positions regardless of the direction of the market. The performance of the Fund will depend on the differences in the rate of return between these long and short positions."
Some Contextual Performance:
A one year chart illustrates (yahoo finance) the performance of BTAL and other alternative options in last year's gradual market swoon of 10% - which occurred from April 2 to June 4, 2012. The two other market hedges shown are both unleveraged and include the popular Ranger Equity Bear ETF (HDGE) and the plain vanilla ProShares Short (-1X) inverse S&P 500 (SH).
Analysis and Opinion:
Note the very respectable gains of over 15% for the BTAL ETF during the end of the market dip. Noteworthy also is the lack of erosion in BTAL. Say the zipper on your bear suit got stuck and/or you got greedy waiting for Armageddon. You also hypothetically of course, did not sell at a timely spot to take profits like you should have. Hindsight, like our old friend "timing" is everything. The BTAL ETF held past its market usefulness in this particular timeframe - did not flesh out overwhelming punishment to your position as it went back down. The others eroded and got crushed. Popular VIX hedges (not shown) such as VXX erode even quicker in a market rebound by steep futures contango and will incur huge losses.
Although this ETF is somewhat designed to be market neutral, when the market is overheated and over bought, it appears some gains can be made in a market dip or correction.
Essentially, it has a net negative beta of around 1.52. This gives a healthy non correlation to the market and could be used strategically to smooth portfolio returns in a diversified portfolio or as what I prefer, as an effective hedge. For example, behaviorally in an overheated market and ensuing market dip, the low beta names like utilities will be in favor, and the high flyer beta names, often tech names, get crushed. The higher beta names go down much more than the low beta. The icing on the cake for me is the much lower erosion if an investor held too long on a market rebound.
BTAL Fund Holdings, Trading, and Expense Details:
The fund has a modest market cap of only around $14 million. The fund can have considerable bid ask spread and only limit orders should be used with knowledge of the NAV price before trading. The BTAL expense ratio is capped and is on the high side at 0.99%, but is on par with similar funds employing exotic strategies, leverage or inverse schemes. More expense cap information should be considered and is available here.
A note of caution is warranted in that this fund may be not intended as a long term buy and hold. It could be very useful as a short to intermediate term market hedge. As such any market hedge should be monitored on a daily basis and active investors should stay abreast for any major change in the investing climate. One down note is the lack of history with the fund. As such, judging from the performance from last year, the BTAL fund performed as a standout hedge in last year's market dip.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.