I had a few questions come in on the follow up to the market neutral pairing of a long sector fund and a double short fund from the same sector such that the exposures offset, mostly, in an attempt to capture a big chunk of the stock market's return (a little price appreciation and a little more yield) with much less volatility than the market.The bigger picture strategy is have a portion of the account generate low beta returns of maybe 6-7% (read the original blog post and the TSCM article I linked to in Sunday's post to see where those numbers come from) with some portion of the total portfolio.
It is a long short trade, only you know how much of such a trade belongs in your account if any. This is an exploration on my part. I maintain positions in Macquarie Infrastructure (MIC) and a covered call CEF to offer a similar effect as what the pair might do; that is above market yield with generally less volatility. It might not work 100% of the time but that is what I am going after here.
One comment said $30,000 (the dollar amount in my example) seemed like a lot of money to tie up in order to lower volatility. Well that was just an example. For someone with $2 million it may be enough to have any effect at all. For someone with $100,000 its way too much.
Pretend for a moment that this paired trade will work exactly as theorized; 6-7% total return with only a fraction of the stock market's volatility. What portion of your portfolio should be in something with these attributes? Maybe zero, maybe 10%? I don't know what is right for you.
Now factor in the risk that this pair may not work as theorized. Maybe it won't work at all or maybe it will be the great strategy ever conceived (I doubt either extreme will be the final outcome).
If it does end up working it creates an effect that could be a proxy for various things. The desired effect here has a place in my portfolio but maybe not yours. One warning about this whole thing is that I have not seen this written about elsewhere so there could be some gaping flaw I don't yet see. If you know of any other folks writing about this please leave the link.
If it can generally work as it did this past week, and I would want to give it more time to prove out, I could see this type of pairing accounting for no more than 5% of a diversified portfolio. So for a $500,000 it would be about $33,000 in whatever you want for the long and about $16,500 for whatever you want for the short, at a maximum.
As far as getting out or not as another reader asks, I have not yet figured out at what point I think it makes sense to rebalance or otherwise exit. This is still a work in progress.
6 comments:
CEFs look so seductive to me. Great yield, sometimes good disocunts. But, no free lunch comes to mind. Would you mind sharing your covered call cef, and how you go about inspecting it for flaws. One thing I have found helpful is to look at the discount chart at etfconnect. Yes, if some of these get beaten down, I would think of buying them for 5-10% of the portflio for higher yield and to lower volatility. Your pairings fascinate me. In theory should work. The unknown, though, is what the yield will be for the short fund. The long fund has a stated yield, but is that open to change going forward? And, another unkown is if one really gets the 2.0 leverage. I believe that you did a very article on how the 2.0 can turn into something less when used over a longer period of time.
FWIW The Morningstar list of 5 star companies that have mid level risk is up considerably over the last week. I don't know the exact number but eyeballing tells me that it has roughly doubled, maybe more. GARP on sale is always good. Tom in Indy
http://www.economist.com/daily/columns/marketview/displaystory.cfm?
story_id=8796484
Rodger et al, Good concise read on liquidity and vix. But, can you dumb it down even further? from the economist, the mag. Is it worth watching hi yield bonds as "the" canary?
the canary? I don't know. A canary, yes. I htink I have touched on this here before but certainly else where.
Tight spreads are a warning and spreads have been tight for a while. When they are tight they will eventually widen. I don't think there is much to suggest how long spreads remain tight as a predictor of when but this should be watched.
What you continue to miss is that there is an additional cost to being in a double-short fund/long fund combination. Specifically the cost is erosion of time premium. I believe that is what you're witnessing when you look at these fund's returns over longer and longer periods of time.
It's not that the fund doesn't generate 2x in the short term - they probably do, but it's the constant rebalancing and inherent burning of time premium that eats up the returns.
Look at the risk characteristics for any of these structured short funds on Morningstar. The burning of time premium shows up as negative alpha. Find any that have a positive alpha? Then I'm interested. (Hint, one does, but it's not a structured product).
If you think about it ones success with any of the "structured" short funds is predicated in being not only right, but timely.
anon 5:24
vaguely implying there might be a better tool for this concept without being specific helps no one thus your point in even commenting eludes me.
If you are saying I'm dumb, I already have family for that.
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