BTAL: Reduce Drawdowns And Increase Your Portfolio Sharpe Ratio

| About: QuantShares U.S. (BTAL)

Summary

BTAL provides a unique strategy that captures the spread in performance between low beta stocks and high beta stocks in a convenient investor-friendly ETF wrapper.

BTAL has the characteristics of a hedge as the ETF generally performs well during market declines and poor during market advances.

The ideal portfolio allocation is 70% SPY and 30% BTAL, resulting in a CAGR of 9.7% with a maximum drawdown of 6.6%.

Assets Under Management is low, approximately $7.7m, thus costs could be high or the ETF could be cancelled in Nov 2017.

I have done a lot of research into hedging strategies over the last several years and have had issues with pretty much every one of them until now. I recently discovered the QuantShares U.S. Market Neutral Anti-Beta ETF (NYSEARCA:BTAL) and it is, if used properly, the best general hedge for equities I have found to date. I have hedged with short ETFs such as the ProShares Short S&P 500 ETF (NYSEARCA:SH) and the ProShares UltraShort S&P 500 ETF (NYSEARCA:SDS). I have allocated a percentage of my portfolio to the SPDR Gold Trust ETF (NYSEARCA:GLD). I have balanced my holdings with Bond ETFs such as the iShares 20+ Year Treasury Bond ETF (NYSEARCA:TLT). But none of these strategies come close to BTAL.

What is an Anti-Beta Fund?

Anti-beta is a market neutral strategy that holds low beta stocks long and shorts high beta stocks. The fund performance depends on the differences in the rates of return of the long and short positions. Low beta stocks are those stocks that are less volatile than the market index, and high beta stocks are those stocks that are more volatile than the market index. The Fact Sheet for the QuantShares fund states that the average beta of the 200 long stocks is 0.77, while the average beta of the 200 short stocks is 1.33. Note: A beta of 1 has the same volatility as the market index.

The difference in return generated between the long positions and short positions is what determines profits (or losses). Regardless of the direction of the overall stock market, the fund will have a positive return so long as the long positions outperform the short positions.

BTAL is not only market neutral and dollar neutral, but also sector neutral and is not levered. Being sector neutral ensures that the ETF isn't simply long in traditional low beta sectors and short sectors that traditionally have high betas rather, BTAL consists of both long and short in all sectors.

Recent BTAL Sector Weights

Sector

% Long Weight

% Short Weight

Basic Materials

4.01%

-4.00%

Consumer Goods

10.01%

-10.00%

Consumer Services

13.02%

-13.02%

Energy

6.00%

-5.99%

Financials

23.53%

-23.56%

Health Care

9.52%

-9.47%

Industrials

17.08%

-17.12%

Technology

11.03%

-11.01%

Telecommunications

1.00%

-0.99%

Utilities

5.00%

-4.99%

Since the portfolio maintains long positions in low beta stocks and short positions in high beta stocks, BTAL generally performs well with declining markets and performs poorly when markets are rising.

BTal Stock Chart

BTAL Stock Chart

The price chart of BTAL is not impressive to look at. When I was researching this ETF, I found that some so-called "experts" declared that BTAL could be held as a defensive fund. Every time I read that wonderful piece of advice I cringed. OK, if your market timing is spot on, then maybe you won't lose your shirt holding this ETF. But if you are like the rest of us normal investors, then you need a better strategy. The strategy that I am going to describe is to use BTAL as a hedge for the other equities that you hold.

Below are the results of some backtests that I performed using Portfolio123. The backtests involved holding BTAL and the SPDR S&P 500 Trust ETF (NYSEARCA:SPY) in different percentages, rebalanced every three months, starting from 09/13/2011, which is the inception of BTAL. The first run held SPY (100%), the second run was SPY (90%) / BTAL (10%), SPY (80%) / BTAL (20%), down to SPY (50%) / BTAL (50%).

Simulation runs with varying percent holding of SPY and BTAL

As can be seen from the above chart, as the percentage of BTAL increases relative to SPY, the overall performance decreases, but the equity smoothness improves, and drawdown decreases.

The maximum Sharpe Ratio of 1.64 occurs with an allocation of 70% SPY and 30% BTAL.

Sharpe Ratio and Beta for various SPY / BTAL mixes

Below is a summary of yearly annualized gain for each percentage allocation of SPY and BTAL.

Yearly performance for each SPY / BTAL percent allocation

SPY-BTAL

2012

2013

2014

2015

2016

100-0

15.99%

32.31%

13.46%

1.23%

12%

90-10

13.83%

27.37%

13.04%

1.32%

10.20%

80-20

12.20%

22.08%

12.58%

1.02%

8.70%

70-30

9.65%

17.16%

12.13%

1.12%

7.05%

60-40

7.42%

12.26%

11.60%

1.03%

5.39%

50-50

5.12%

7.59%

11.12%

0.93%

3.72%

The chart below shows the price chart of SPY along with the optimal allocation of 70% SPY and 30% BTAL. As can be seen from this chart, the maximum drawdown is significantly less with the balanced combination, but sacrifices overall return.

Price Chart of SPY and optimal balance between SPY and BTAL

Why I like this strategy

I tried to get beat the overall performance of the 70% / 30% strategy using SPY with other hedging strategies, including the iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA:VXX), iPath S&P 500 VIX Mid-Term Futures ETN (NYSEARCA:VXZ), TLT, and GLD. I was unable to get down to 6.5% drawdown with any percent allocation for any of these instruments. I was able to get to the 6.5% drawdown with SPY (82%) / SDS (18%) but the overall performance was significantly less than for SPY (70%) / BTAL (30%).

Below shows the simulation results for these two configurations, along with two long/short ETFs: the Credit Suisse Long/Short Liquid Index ETN (NYSEARCA:CSLS) and the ProShares RAFI Long/Short ETF (NYSEARCA:RALS).

The 70% SPY / 30% BTAL outdistances all of the other hedged strategies by a fair amount. The nice thing about BTAL is that the long / short beta strategy wrapped in an ETF gives investors an opportunity to access a technique that would otherwise be beyond their reach, given the time and expense of rebalancing 400 stock positions each month.

BTAL Characteristics

Characteristic

Long

Short

Number of Companies

200

200

Price/Earnings Ratio

24.25

23.33

Price to Book Ratio

3.07

1.9

Avg Market Cap

23.39b

15.29b

Median Market Cap

9.39b

5.73b

Now for a word of caution. The Assets Under Management (AUM) is listed as approximately $7.7m. This is a small amount by ETF standards. The Net Expense Ratio is listed as 0.75%, but the Gross Expense Ratio is 3.13%. There is a note provided in the Fact Sheet as follows:

FFCM has agreed (I) contractually to waive its management fees and reimburse expenses until November 13, 2017 to the extent necessary to prevent the Fund's net operating expenses (excluding interest, taxes, brokerage commissions and other expenses that are capitalized in accordance with generally accepted accounting principles, dividend, interest and brokerage expenses for short positions, acquired fund fees and expenses, and extraordinary expenses, if any) from exceeding 0.75%.

Given the low AUM, I'm not sure what will happen after Nov 2017. It is conceivable that the ETF could be shut down or the expenses dramatically rise.

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.

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