The Defensive Investor's Tool; New Canadian ETFs; Inverse Exposure to Emerging Markets

Yesterday, I had a last minute invitation to speak on Canada’s Business News Network … that’s not a description, that’s its actual name. The channel was formerly known as “Report on Business Television” so you’ll have to decide if their name change was an improvement or not. The six and a half minute clip will be available for viewing online here until sometime late Monday evening of next week (when you click on this link I’ve provided, a small window with a built-in media player should pop open). If this doesn’t work, then go here and scroll down to the 4:40pm “After Hours” program.

The opening shot of me appears to be my poker face of I’m about to enter the octagon for combat or it’s the once-a-month event when I screw up WordPress and lose a big chunk of my blog posting. Either way, it’s my “death stare” and I can only imagine that I felt pretty lousy running from my car to the building entrance of the studio in what has to be Toronto’s heaviest rain storm so far this year.

Anyway, the discussion was on market volatility but unfortunately the focus was almost entirely on VIX. I say “unfortunately” only because VIX can be (well, it is) a dry subject due to its rather technical nature. Despite being on the channel several times before, you’ll note that the topic of VIX was not quite enough to get me really loosened up until just a tiny bit near the end.

Well, here are two charts which I discuss during the interview:

3 Year VIX Chart

17.5 Year VIX Chart

I was hoping to get into a discussion on emerging markets, gold and oil markets, and a broader geopolitical debate. But at the end of the day, VIX is a tool worth considering for the defensively oriented investor, so there’s merit in its discussion. Along with outright shorting and inverse ETFs, there’s not much out there in terms of true diversifiers/stabilizers available in this high correlation world.

On the other hand, I have actually noticed lately that a lot of hedge funds (fund-of-funds, multi-strategy funds and even some single strategy funds) have had better than decent performance in 2007 YTD. Could it be a result of the VIX spike up since late February? I’m sure it’s more than that but this good performance comes after a fairly long period of so-so returns.

On a separate note, after my interview, I had dinner with one of the ProShares directors who was up here in conjunction with Horizon BetaPro’s launch of their new Canadian energy sector index levered and inverse ETFs. This follows up BetaPro’s launch last week of similar long and short exposure ETFs for the Canadian financial sector.

Based on this BetaPro press release (.pdf) from April, it’s safe to say that we’ll be seeing the gold sector ETFs sometime soon as well.

For review, this is BetaPro’s lineup as of today:

Horizons BetaPro S&P/TSX 60 Bull Plus ETF - HXU
Horizons BetaPro S&P/TSX 60 Bear Plus ETF - HXD
Horizons BetaPro S&P/TSX Capped Financials Bull Plus ETF - HFU
Horizons BetaPro S&P/TSX Capped Financials Bear Plus ETF - HFD
Horizons BetaPro S&P/TSX Capped Energy Bull Plus ETF - HEU
Horizons BetaPro S&P/TSX Capped Energy Bear Plus ETF - HED

The Canadian ETF marketplace has basically doubled in a very short time especially due to the recent product development efforts at both BetaPro and Claymore. Unlike in the U.S., we don’t have as robust - some may say saturated - ETF marketplace here in Canada. Frankly, we don’t have the broad acceptance of ETFs here like there exists in the U.S. so there is some balance there. I would guess by looking at reports, such as those from Deb Fuhr at Morgan Stanley, that all other markets outside of the U.S. also have a rather small but growing ETF industry and that is likely where we’ll see significant growth as the ProShares, PowerShares, WisdomTree and other smaller participants do the same as BGI, SSGA and Vanguard with its already established global expansions.

I won’t get into the discussions I had with the gentlemen from ProShares except for the fact that I asked the question that I think many want to have answered: When do we get the international exposures?

I’ll just leave you with a “let’s wait and see”. Let me be blunt as usual … I’d kind of like to see them, specifically inverse exposures for EAFE and emerging markets available before the end of the summer. Certainly before the end of the year.

Oh, and one last thing to consider for those of you who want to get some inverse exposure to emerging markets. I don’t know if that’s the right call (bearish on emerging markets) but considering the strong run up in China, central/eastern Europe and basically all subgroups in the developing world, it’s worth making preparations. But what to do when there’s no inverse ETF and shorting EEM or VWO is the only reasonable alternative? I suggested to my dinner partner from ProShares that the BetaPro S&P/TSX 60 Bear Plus Fund might be a good choice especially considering the relatively high correlation between the Canadian equity market (TSX 60) and a broad emerging market ETF like EEM. I would only guess that the new inverse energy sector ETF from BetaPro would be an even better proxy for a short EEM strategy. There’s not enough historical ETF data but your friendly neighborhood Bloomberg terminal, Thomson Datastream or similar data source should provide you with data for the underlying index as the evidence you need.

It’s a tough, high correlation world. But perhaps there are ways like this to use high correlations to your advantage. The problem is correlations change in time. I’d much rather have the inverse ETF.

Comments

[Go West:]

Richard, The management fees on these Horizons ETFs seem a bit outrageous at 1.5. I am alone in thinking that something is weird when the sponsor is paying a trailing commission on a ETF? And who is managing the futures portfolio for them, these Horizons folks are just marketers.

2007 Jun 20 01:14 PM

[Richard Kang1:]

RS: First, the unfortunate fact is that we Canadians seem to be unconcerned about the fact that fees overall in the financial services industry are higher here than elsewhere in the world. Evidence of this in the fund industry specifically can be found in this paper: papers.ssrn.com/sol3/p...

The portfolio advisor to the Horizon BetaPro products in Canada (both mutual funds and ETFs) is ProFunds out of the US, the same manager of the ProShares family of levered and inverse ETFs.

Yes, the fees for levered/inverse ETFs both in Canada and US are high in relative terms versus other more vanilla, non-levered ETFs for a number of reasons. I would only wonder if investors really care about fees in these cases if it's fair to assume that most investors who use levered/inverse ETFs are only in them for the very short-term. Would investors hold the levered long S&P 500 ETF when they can use something like SPY or a similarly cheap Vanguard fund/ETF? Only the somewhat sophisticated investor who wanted to free up cash for some "portable alpha"-type strategy would consider the levered long fund approach. Perhaps there are a few other similar reasons but not too many I think.

Despite what anyone might think about the relatively high fees, you can't deny that both BetaPro in Canada and ProShares in the US have been successful when you consider their assets under management growth from the inception of their ETF operations. These products are for active investors, not the low-cost, efficient market, Bogle/Malkiel followers. The success of these products, I think, proves that in the ETF space but especially with levered/inverse products, fee sensitivity is not the major issue.

2007 Jun 21 10:01 AM