The S&P 500 High Beta ETF: Here's How To Trade It

Summary

• The Invesco S&P 500 High Beta ETF selects the top 100 most sensitive stocks in the S&P 500 over the past year.
• But the time to invest in a high beta fund was many months ago, and now, the risk to return ratio doesn't make sense.
• The ETF still holds several high-potential stocks in cyclical industries like Travel Services, Airlines, and Resorts & Casinos, but their futures are very uncertain with the Delta variant in play.
• This article will provide investors a simple framework for determining when to rotate in and out of sensitive ETFs like SPHB.

marrio31/iStock via Getty Images

Investment Thesis

The Invesco S&P 500 High Beta ETF (SPHB) is anything but a buy-and-hold fund. Investors need to be extremely careful about choosing entry points because, over the long run, the S&P 500 is easily the better pick by both absolute and risk-adjusted returns. Thankfully, determining these entry points isn't rocket science. In this article, I will describe a simple method you can use to time your trades. Though the time to invest in SPHB was many months ago, the impact of the Delta Variant could change everything, and the next time you'll know what to do.

SPHB Overview

SPHB tracks the S&P 500 High Beta Index, selecting the 100 most sensitive stocks in the S&P 500 (SPY) over the last twelve months. Fees are a modest 0.25%, and the Index reconstitutes quarterly on the third Friday of February, May, August, and November using data from the prior month. Weights are assigned proportionally to a company's beta.

Being a high beta fund, it's not surprising to see Information Technology, Consumer Discretionary, and Energy at the top of the list. Financials total 19.34% of the fund, too, but the majority of these stocks are in industries like Regional Banks (7.49%), Insurance (4.58%), Asset Management (3.42%), and Credit Services (3.07%).

Source: Invesco S&P 500 High Beta ETF Overview

Invesco updates the top ten holdings daily, as shown below. Due to its weighting method, they total just 13.49% of the ETF.

Source: Invesco S&P 500 High Beta ETF Overview

As for performance, I don't think there's any question that SPHB makes for a poor core holding. Since its inception, it's lagged SPY by 1.73% per year and experienced more risk as measured by standard deviation. While higher risk is precisely the point of the ETF, the poor Sharpe and Sortino Ratios, two traditional risk-adjusted return metrics, indicate long-term investors aren't likely to benefit from this strategy.

Source: Portfolio Visualizer

Developing A Simple Technical Framework:

While not an appropriate core holding, there are significant upsides to trading in and out of SPHB and SPY. The following table shows the ten worst drawdowns of SPY in the last decade. I've added the corresponding forward returns based on the length of the drawdown in question. For example, if the drawdown period lasted three months, the forward-looking period would also be three months.

Source: Created By Author Using Data From Portfolio Visualizer

It's telling and perhaps quite obvious that in nine out of the ten periods, SPHB went on to outperform SPY after the drawdown. Often, the performance was significant. For example, from April to June 2020, it beat by 17.40%. Even going back to October 2011 to June 2012, the outperformance was nearly double digits. Intuitively, it makes sense as well. Managers are rebalancing client portfolios, and value investors see more opportunities.

The key to this strategy is to keep your forward outlook roughly the same length as the drawdown period. Often, rebalancings are done primarily to comply with a portfolio's investment policy rather than a change in perspective. The last thing you want to do is give back your gains because you held too long. Instead, the goal is to take advantage of short-term trading behavior.

However, a flaw with the drawdown method is that investors never really know when the drawdown will end. In March 2020, it was hard to imagine the stock market would disconnect itself from reality as much as it has, but here we are. To simplify things, I suggest using SPY's trailing two-month return (roughly the length of the average drawdown) as a leading indicator. I made some calculations, and since July 2011, the average two-month return was 2.44% with a 5.24% standard deviation. Assuming a normal distribution puts the confidence interval for two-month returns anywhere between -8.04% and 12.92%. Let's now simulate the performance of an investor selecting SPHB when the market has fallen more than 8% over two months and SPY as the default asset otherwise.

Source: Created By Author Using Data From Portfolio Visualizer

As shown, the strategy of only owning SPHB when SPY's two-month returns have dipped below 8% paid off well. The portfolio grew to $47,731 in ten years from August 2011 to July 2021, or at an annualized rate of 16.92%. This beat SPHB and SPY by 2.90% and 1.68%, respectively.

As of the end of July, SPY has returned a cumulative 4.74% in the last two months. In other words, it's not even close to the threshold. We're going to need another significant correction before SPHB becomes attractive again.

We Must Be Objective

You may look at SPHB's composition and think there is room left on the runway for growth. Indeed, the average stock had a 3.79% positive revenue surprise last quarter. Nearly 15% of the ETF is in Travel Services, Airlines, and Resorts & Casinos, which are still trading at about the midway point between their 52-week highs and lows. SPHB's 17 Energy stocks are trading, on average, 8.58% below their 50-day moving average prices. Still, we must remain objective. To put things in perspective, here are some weighted-average statistics for SPHB's top 15 industries, which comprise about two-thirds of the fund.

Source: Created By Author Using Data From Seeking Alpha

Revenue growth rates are terrible. Even on a five-year annualized basis, SPHB's constituents have only grown it at 3.44%. The low single-digit return on assets is perhaps even more disappointing. Coupled with the high five-year beta of 1.44, it becomes clear that these aren't just high-risk plays. Many are deep value plays in a highly uncertain economic environment. I can't justify the risk without a significant market correction first.

Investment Recommendation

The S&P 500 High Beta ETF works best during market corrections, roughly in the 8% range. At this point, portfolio managers are bound to rebalance client portfolios by purchasing assets in the most unloved industries, which SPHB will likely be holding. At other times, though, it doesn't make much sense to own. Over the long term, it underperforms the S&P 500 and not only has worse risk-adjusted returns but has worse downside risk-adjusted returns.

Since the S&P 500 has returned 4.74% between June and July, we're nowhere near the -8% trigger point. As such, my recommendation falls somewhere between bearish and neutral. I'm recommending investors be patient while we see the impact the Delta variant will have on markets and lean a bit more on the low-end risk spectrum instead.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of SPY either through stock ownership, options, or other derivatives. 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.

Comments

[SeekingTruth]

Good observations and interesting technique. Thanks.
Also, since SPY and SPHB are highly correlated , for a Buy, one would like to see SPY and other well chosen selections in a rebound for confirmation and support.

Now you seem to be at Neutral (Hold).
Do you have any keys, technical, and otherwise, for a Sell?

[The Sunday Investor]

@SeekingTruth Try monitoring median six-month returns by sector for a large basket of stocks like the S&P 900. I've found that during periods of high volatility among sectors, the best-performing sectors tend to do the worst over the next six months, and vice versa.

The end of July marked the end of that "high volatility" period, though, but if you were following that you would have been part of the Financials sector comeback. Another example is that as of the end of June, the strategy would have called to be overweight Utilities, Consumer Staples, and Health Care (the three worst-performing sectors on a six-month trailing basis). They ended up being the 3rd, 8th, and 1st best sectors in July. An ETF like SPHB will pretty much never hold much in these sectors, so that was the primary reason it underperformed SPY by over 6% in July. On the flipside, Energy had the best six-month median returns as of June 30, and then went on to be the worst-performing sector in July. Financials was in 2nd place, and then was the 9th-best. Finally, Consumer Cyclicals was previously in 3rd place but was in 7th place in July.

In my view, investors often get too caught up in the style/strategy of a fund and not about what it's actually holding. Taking a bit more of a macro view has been helpful to me.