To improve diversification and prevent single company or single industry blow-ups (think gold stocks most recently), I'm always on the lookout for mutual funds, closed-end funds, or ETPs (exchange-traded products) that provide much of the upside of the well or luckily-selected leaders in a sector or national market which mirror our own strategies.
One strategy we like to use when we believe the market is looking frothy is trailing stops. Whenever the market hits new highs, suddenly everyone who missed the preceding move suddenly awakens and decides they need to buy now. This is usually the worst time of all to initiate positions, hence our use of trailing stops at these important junctures. I've never found a fund or ETP that does this for us - until now. We still need to watch these positions every day to decide when it's best to use them and when it's best to select individual equities, but at least these automatically reallocate like we like to do with our trailing stops.
There are a number of these ETNs offered by the Royal Bank of Scotland (whose preferreds we own in the Growth & Value Portfolio) but some have too little volume to consider. On the other hand, there are two that I believe merit your attention. Even these are thinly traded compared to more established ETNs and ETFs (they are only a couple years old) so, for heaven's sake, buy in multiple tranches and use limit orders.
The RBS US Large Cap Trendpilot ETN (TRND) fits my goal to "automatically" add exposure "when the fish are running" and reduce it when they are not. Here's how they do it: they use a trend-following strategy to provide exposure to buy the S&P 500 Total Return Index when the indicator they use says to be invested, and when the indicator says "Danger, Will Robinson, Danger!" to invest in an index that instead mirrors 3-month U.S. Treasury bills. If the level of the S&P Index remains at or above its historical 200-Index business day simple moving average for five consecutive business days (a "positive trend"), TRND will faithfully track the return of the S&P. Conversely, if the level of the S&P 500 falls below the 200-day moving average for five consecutive Index days (a "negative trend"), then TRND will effectively switch to cash instead of the S&P.
Two things to be concerned about with such a strategy and two to like:
While our purchase decision is trend "anticipation," the actual product we are using is trend "following." TRND will always be a couple to a few days late in buying in and a few days late getting out from the actual bottom or top. I don't see that as a huge disadvantage. Nobody catches the exact tops and bottoms; that's a fool's errand. Second, you might be whipsawed occasionally, although the 5-day rule tends to mitigate that somewhat.
So what's to like? Risk mitigation. The grayer my hair gets, the less I like to see large losses. Just one blow-up from one company or industry (did I mention gold miners?) can destroy all of one's hard work. By building a foundation of ETNs like TRND, we can be sure we capture most, but never all, of a series of "perfect" calls by the alleged smartest guys in the room. Buying TRND will increase our edge even more. Through the end of the 1st quarter, the benchmark S&P was up 10.6%, TRND was up 10%. Since inception, the benchmark S&P was up 24.6%, TRND was up 21.8%. John Paulson's gold hedge fund during this quarter? Down massively. Which would you rather own?
TRND is currently well above its 200-day moving average, so it may come down a good bit before the "go to cash" signal is given (though that will change as the 200-day MA catches up. But lately we've been buying more of the RBS NASDAQ 100 ETN (TNDQ) than TRND.
TNDQ, the younger brother of TRND, is even more thinly-traded. I have been slowly buying it for clients but, in order not to move the market, in 250- and 500-share lots. Because of the NASDAQ 100's April underperformance, TNDQ is much closer to the 200-day MA, so if there is a decline, it will go to cash much more quickly, preserving more of our capital.
Like TRND, TNDQ invests in either the NASDAQ 100 Total Return Index or the yield on a notional investment in three-month U.S. Treasury bills. The difference is, since this index tends to be more volatile, RBS buys the NASDAQ 100 Index when it is at or above its 100-day simple moving average for 5 days and goes to cash when the index closes below its 100-day simple moving average for 5 consecutive sessions. We now own both.
What We are Not Protecting with Trailing Stops
At times like this, when the market may be approaching a top, we still don't go overboard and sell everything. After all, the bias of the market is to drift upwards in the absence of bad news. It goes up roughly 2/3 of the time and down only 1/3 of the time. (The past 13 years being a notable exception, of course) So here's what we are sticking with and a brief reason why.
We're sticking with our long/short mutual funds because, while they may be roughed up in a general decline, their charter allows them to get knocked down along with the market but to get back up and fight again another day. The best most mutual funds can do is go to cash. Most of the time they aren't that smart, so they fall back on the crutch that, long term, the market always comes back.
We're also keeping most of our balanced funds. Their track record in the bad times is a good one and we want to keep some of that long-side positioning. We'll keep Lynas (OTCQX:LYSDY) because we are so far underwater they wouldn't bring us much, anyway, and because China's days of manipulating the REE market are coming to a close. When the world's economies pick up, these economy-sensitive issues have the potential to blow the doors off.
We'll keep our boring telecoms because they provide great income and "relative' stability, and we'll keep our First Trust NASDAQ ABA Community Bank (QABA), and likely add specific smaller banks, because they are bastions of safety. Finally, we'll keep and add to our more stodgy "big energy" firms such as Schlumberger (SLB), Royal Dutch Shell (RDS.A) and Statoil (STO). Whenever they decline, we buy. That strategy has worked for us for 40 years, beginning when I first entered this business.
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