Previously, we explored long-biased Hedged Convexity Captures, a strategy which seeks to capture the negative convexity associated with leveraged ETPs. The idea behind Hedged Convexity Capture, as I outline in my book, is to capture the potential returns from shorting leveraged inverse equity ETPs with lower drawdowns and far higher Sharpe ratios than by just shorting them outright. The strategy seeks to accomplish this by shorting leveraged inverse equity ETPs like SPXU and pairing that short with a short position in TMV , an inverse leveraged long bond ETP.

Not only does shorting TMV often provide a hedge for the equity portion of the strategy, but TMV itself suffers from negative convexity, further increasing the effectiveness of the long bond hedge.

As before, we will use some simple rules:

I. Short SPXU with 50% of the dollar value of the portfolio

II. Short TMV with 50% of the dollar value of the portfolio.

III. Rebalance weekly to maintain the 50%/50% dollar value weighting between the two instruments.

Here is a graph of the results YTD.

The strategy is outperforming the S&P 500 this year by 11.8% points. And contrary to the worries of some critics, it has proven to be far safer in a choppy market than merely holding equity indices. This does not mean that this massive outperformance will continue, but it does mean that the strategy is well worth further exploration.

My personal view is that the strategy will continue to underperform during strong bull markets, but will outperform during choppy and bear markets for equities. Of special interest is the high Sharpe, combined with a CAGR divided by Max Drawdown that far exceeds that of the SPY ETP over the same time period with a correlation to the SPY of only 0.63 YTD.

However, even though the strategy tests well, I never rely on theory alone. The advanced non-public version of this strategy uses a systematic switch to enter and to exit the strategy to further reduce risk. I believe the strategy's major risk, since it uses shorting, is a discontinuous drop in markets which causes the SPXU leg of the trade to skyrocket far more than the TMV could drop. As I often say, no strategy is even close to perfect. There are only strategies which are preferable to all other possible alternatives. We have created an advanced non-public version of the strategy for clients which does not use shorting. I think the public version presented here has the ability to stimulate thinking on the part of investors by clearly illustrating that even seemingly simple strategies using powerful mathematical principles can dramatically outperform strategies presented in popular bestsellers like the Magic Formula books, while using fewer instruments with less hassle to implement.

Investors are constantly bombarded with intuitive strategies. And intuitive strategies may be excellent marketing vehicles, but they are often far worse performers than non-intuitive strategies. Strategies which rely upon an understanding of pure mathematics have a higher probability of sustained outperformance, because most people are not wired to feel emotionally comfortable with mathematical strategies.

It is this emotional discomfort which not only hinders the popular adoptions of such strategies, but also creates the potential for sustained outperformance for those unique investors who do appreciate their logic.

**Disclosure: **I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.