Well, no coffee in the picture but a good dog photo nonetheless.First some humor.
The other night I watched the end of the Nevada Utah State basketball game. After the game something called Creative Breaking came on. It was a competition where some martial arts dudes broke stacks of cement bricks and boards of wood in, well, creative ways.
We were mesmerized but what was some really, really bad television. Really bad.
Last October I started writing about pairing a sector ETF with a not yet listed double short sector fund in a market neutral sort of thing. When the double short sector funds from ProShares came out I wrote about this trade in more detail on TheStreet.com about a month ago.
I thought that last week's stress test might be a good time to revisit the trade and see how it held up.The example I used in the TSCM article was $20,000 in WisdomTree International Financial ETF (DRF) and $10,000 into the ProShares Double Short Financial ETF (SKF).
If both were bought at the open last Monday it would be 698 shares of DRF at $28.62 and 145 shares of SKF at $68.58 totaling $29,920.86. At the close on Friday DRF was down to $26.79 and SKF was up to $76.00. The total value of the combo was $29,719.42, a decline of $201 or 67 basis points. Well, not too shabby
The idea behind the idea is over longer periods of time is to capture a percentage point or three of outperformance (a bet that DRF will outperform the DJ Index that underlies SKF, which is the same index mimicked by iShares Financial ETF {IYF}) and capture some yield from both ETFs with much less volatility than the overall market.
Hopefully it is clear that this combo will woefully lag when the market is up a lot.
It also worked for utilities. WisdomTree Utilities (DBU) was down almost 5%. For kicks I threw in the Macquarie Infrastructure ETF (GII) which I posited is a proxy for global utilities, it was down closer to 4% and the Proshares Double Short Utilities ETF (SDP) was up not quite 10%.
Last one; the materials sector. iShares Global Materials (MXI) was down about 7% and the ProShares Double Short Materials ETF (SMN) was up 15%. But the yield from MXI is relatively slight.
So I would say the concept passed its first test. Let's see where we stand after a year has gone by and the funds have paid out what I think they will pay out. DRF, IYF, DBU and MXI are client holdings here and there but none of them are widely held.
One point that I don't think came across in this week's video is that if the market is going to correct or go into a bear or crash or whatever, the market's PE being 15 (if that is what is, I don't know for sure because I don't care) will not matter. The market's PE ratio has a lousy predictive track record. Further, fundamental measures like this one mean nothing during market dislocations. If you don't think this is a market dislocation you may be right but you may want to hold on to this point for the next time you think there is a dislocation.
Toby Smith said something weird on Bulls and Bears that was easily missed. He said "I know we don't like to talk about currencies here," or words to that effect. I recall hearing something along these lines before. Despite Fox News not wanting to delve, I reiterate that studying currency markets even if you don't trade currencies is very worthwhile.
Lastly, Joey Bats says he bearish!
9 comments:
Do you also include a calculation for the time value of money, in setting up the offsetting positions?
The pairings are interesting in one regard which is domestic-v-foreign, which gives you coverage against large foreign currency swings.
Lastly, do you stay fully invested rather than get out of positions entirely as a matter of strategy? Rather than hedge, some advisors go to cash during times like these. Thanx, OldVet
Thanks for exploring this topic Roger. I tried some pairs-trading ideas in the past but couldn't get them to work -- there were typically period(s) of more variance than expected so return fell within the margin of error (increased risk of a loss after trading costs and slippage) -- so I turned to call-writing ideas for reduced volatility w/ a bit of performance boost. Look forward to hearing more about this.
Joey Bats is bearish? Shoot, now I have to re-investigate my own bearish thesis ;-)
Actually though, I think the odds of an oversold bounce next week are as good as the odds of a further drop but, that said, there does seem to be a distinct change in psychology; net money flows are going out of equities rather than in (however note that this can happen and prices still increase if volume is subdued).
Oops, meant to post a link (and hat tip to Kirk Report) WRT equity flows: http://tinyurl.com/3adcx2
http://stockcharts.com/charts/gallery.
html?$OEXA200R
A lot of exit plans revolve around the 200dma. My own large caps that I follow are near the 200dma. Above link is for percent above.Close to its own 200dma. The relative strenght line bodes badly.
Appreciate the follow up on the hedge pairing. Just seems like a lot of money to tie up in order to lower volatility, but as I get older the concept make take traction. Longer term I'd be looking to compare the strategy to bonds,cash, hi yield cef.
PE's matter at extreme levels: the long-term return is much better when starting with a PE below 11 than starting with one above 18.5, as shown in this article:
http://tinyurl.com/3243df
the context is whether there is a panic or not. panics vs. the long term are two different topics and low or high pe's will mean nothing over the next six weeks or whatever.
Roger, is there any reason you pick wisdom tree int'l financial ETF over the one on iShares'(IXG, IYG)?
The long needs to be capable of beating IYF which shares the same index as the double short. For now I tend to think that means WisdomTree for both its yield and what has so far been outperformance of the other choices to go long.
My colleague and I just wrote another article you may be interested in: "Leveraged ETFs: A Value Destruction Trap?"
It shows the perils of a fund trying to maintain constant leverage during a bear market, which is what the Ryder and ProShares ETFs do.
In order to maintain their leverage ratio, these funds buy lots of shares during a bull market, and then sell them all during a downturn, with devastating results which they just can't recover from.
Here's the URL:
http://etf.seekingalpha.com/article/31195
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