Our investment account lost about 2% in October. This return lags the 6.6% return of S&P 500 in the month. The underperformance is very typical in the initial recovery phase of the decent size correction we experienced in August-September. While S&P 500 climbed significantly after hitting short-term bottom on September 28th, our SPY/TLT strategy remains in full bear mode and still holds TMF, 3X TLT for the time being. Our VXX/XIV strategy turned bullish early in the month and currently hold XIV. This strategy had a nice 15% return during the month.
We have put the XIV/VXX strategy under review. The strategy had fantastic returns from the end of 2011 to October 2014. The strategy has been struggling ever since, however, with several false signals and very fast and large draw downs. A good example of lightening fast and large drawdown is the 39% drop of XIV from August 17 to August 24. There are two potential reasons for the underperformance of the strategy. The first is the cyclical underperformance of shorting volatility at the end of a major bull market and the beginning of a bear market because VIX generally rises in this phase and will hurt performance of the roughly shorting VIX strategy. Furthermore, shallow corrections are very common in this phase. This can lead to false trading signals and reduce the performance of the strategy even further. This happened in 2007-2008 and perhaps in 1998-2000 if there were VIX futures at the time. The other potential reason is very troubling. Many new traders have been attracted to the strategy due to the nice recent returns. A direct consequence of a crowded strategy is higher volatility and reduced returns. This seems to be the case with elevated "VIX of VIX", i.e. the volatility of VIX index itself, during the past two years. The proliferation of VIX ETPs that made VIX trading accessible to a much wider range of traders certainly exacerbated the situation. We think the underperformance of XIV/VXX strategy is likely due to combination of both reasons. It remains to be seen if the change is structural and will reduce performance of this strategy in the long run. Nevertheless, it'd be wise to review the strategy and potentially reduce the weight of the strategy in our portfolio.
At the end October, we hold ~70% of our portfolio in TMF and ~30% in XIV.