I have often said that excellent strategy indices should be elegantly Zen - simple, powerful, and effective. Many people mistake complexity for power or effectiveness. Today, we will examine an index that is elegantly powerful and effective. Then, we will examine ways to improve it.
Here are the Ultra-Low Volatility Index's rules:
- Buy ZIV (NASDAQ:ZIV) with 20% of the dollar value of the portfolio.
- Buy UPRO (NYSEARCA:UPRO) with 40% of the dollar value of the portfolio.
- Buy TMF (NYSEARCA:TMF) with 40% of the dollar value of the portfolio.
- Rebalance weekly to maintain the 20%/40%/40% dollar value split between the positions.
Here are the results:
The logic behind the strategy is that ZIV, the inverse mid-term VIX futures ETP, is a return generating component of the strategy by capturing the contango which exists (on average) in mid-term VIX futures.
UPRO is a 3x leveraged S&P 500 ETP. It is a return generating component of the strategy which gives leveraged stock market exposure.
TMF is a partially hedging component of the strategy through a 3X leveraged long duration government bond exposure. Statistically, often but not always, this instrument moves inversely to stocks, thereby providing an imperfect hedge.
I want to stress that this simple three-instrument index trounces the U.S. stock market, without any stock picking required. This index is a multi-asset class (inverse volatility, equity, and fixed income) and is easily rebalanced.
However, it is also a simplistic public version of our strategy index technology. Many readers of our public pieces believe the profits from our publicly released strategy indices are almost magical compared to anything else they have used.
Even though their gung-ho confidence in our methods is flattering, I am very sincere when I say that our publicly disclosed strategies should be starting points for further investigation on the part of readers - not a combat-ready index that we would provide through our subscription service.
I think it is important for combat-ready indices not only to contain multiple asset classes, properly weighted, but even more importantly, that they have a built-in risk control component. And robust, systematic risk control not only has rules for exit, but also rules for re-entry.
Getting out of something is only half of the equation. Having a systematic method for when to get back in is the other half.
When one studies financial markets during the financial crisis, and especially 2008, it is clear that one not only needs a multi-asset class framework, but also solid risk control rules, in order to try to avoid crippling drawdowns.
Constant crises, drops, and fed policy responses should remind us that systematic risk control is just as important as asset class exposures going forward. For those looking for such an index approach, ZOMMA has strategy index solutions which incorporate risk control.
Thanks for reading. We feature even more impressive strategy indices in our subscription service, with clear risk control protocols. If this post was useful to you, consider giving it a try.
Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown; in fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program. One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk of actual trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points, which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program, which cannot be fully accounted for in the preparation of hypothetical performance results and all which can adversely affect trading results.
Disclosure: I/we 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.