Very Sophisticated ETFs

Owning sophisticated ETFs requires knowing what they can and cannot do.

Recently in an appearance on ETFIQ on Bloomberg, Michael Venuto talked bout the AGFiQ Market Neutral Anti-Beta Fund (BTAL). He was favorably disposed to the fund because he believes it offers asymmetric risk.

The strategy is to go long stocks with low beta and to short stocks with high beta. Venuto said that the fund is capable of having a positive return when the broad market is going higher and probably more likely to have a positive return when the market is going lower.

For some context, the fact sheet reports the fund’s NAV being down 8.36% for one year as of September 30th. The three year annualized number is -0.43% and the annualized five year number is -3.50% versus up 18.61%, 10.81% and 14.22% for the S&P 500 over corresponding periods. That makes a convincing argument that the fund offers a return profile that looks nothing like the S&P 500.

Included in the fund’s history obviously is 2017 which would seem to be about the worst possible environment for this strategy given the extent to which growth has trounced value this year. BTAL is short Amazon (AMZN), Apple (AAPL), Netflix (NFLX) and a few other strong performers without getting much support necessarily from the lower beta, value names.

The fact sheet for each of the five AGFiQ ETFs (more on the others in a moment) are very robust. They include the long and short weightings for each of the sectors. Other than a dividend oriented fund, all of the funds seem to target equal weightings long and short for each sector. That strikes me as making a lot of sense, keeping it a little simpler by being sector agnostic.

The other funds AGFiQ offers are the AGFiQ US Market Neutral Momentum Fund (MOM) which goes long strong momentum and short weak momentum, the AGFiQ US Market Neutral Value Fund (CHEP) which goes long cheap stocks and short expensive stocks, AGFiQ US Market Neutral Size Fund (SIZ) which goes long below average sized companies and short above average and the AGFiQ Hedged Dividend Income Fund (DIVA) which goes long high dividend payers and short the one that pay the “lowest” dividends. I put lowest in quotes, that what it says which implies it doesn’t short companies with no dividends.

CHEP has been the best performer in nominal terms by far, MOM and SIZ have been similar to BTAL, a little worse actually and DIVA has a very short track record.

As ETFs go, these are very sophisticated. The assets are very low in all of them, DIVA with $11 million and BTAL with $9 million are the two largest. To the extent Venuto is correct about BTAL, I think CHEP might offer similar attributes. In the tech wreck, value dramatically outperformed growth but that was reversed in the financial crisis due, IMO, to the tendency of the financial sector to skew toward value, the iShares S&P 500 Value ETF (IVE) has 28% in financials compared to 4% in iShares S&P 500 Growth (IVW).

Using these requires a contextual understanding of what these funds are not. If the market is up 20% then these funds will lag far behind, they are long/short and four of the five have “market neutral” in the name. They have a chance to do better with less dramatic increases in the market. In 2016, according to Google Finance, DIVA and CHEP were in line with the market as value outperformed growth, I would note BTAL was down a little.

I would generally expect value to outperform growth in a bear market. If that turns out to be correct then CHEP could also be a useful tool along the lines of Venuto’s comments about BTAL. Given the semi-unpredictable nature of how inverse index funds trade I am not a fan of using them exclusively for defense.

My use of inverse index funds has typically been as a first move in taking defensive action in a small weighting to let them potentially grow bigger in the portfolio as/if the market goes down a lot. Then I use other products to further reduce net long exposure (beta) and these funds, if they are still around when the next one hits, interest me.

When the time comes I will disclose what I do in portfolios with a one or two day lag (maybe less) just like the last bear market.