Just One ETF: Riding Mid Caps (and Beating SPY) Through Equal Weighting
November 2nd, 2010 | Posted by Global Investors
Christian Wagner is the founder of Longview Capital Management, a Wilmington, Del.-based RIA specializing in personal asset management for individuals, families, institutions and retirement plans. Prior to founding Longview, he worked as director of investment services at Commerce Bancorp in Philadelphia.
Which single asset class are you most bullish about in the coming year? Which ETF position would you choose to best capture that?
In the U.S we are bullish on the mid-cap space. The ETF that we would choose to best capture that would be the Rydex S&P Equal Weight Index Fund (RSP).
How does RSP fit into your overall investment approach? Tell us a bit about your strategy and goals.
Longview is an active, all-asset manager; through the use of relative strength analysis we look for the greatest opportunity across the asset classes that we follow. We continue to see strength in international equities – specifically emerging and frontier markets – as well as domestic equities – specifically, the small and mid-cap sectors with an emphasis on commodities, energy and transportation.
The Rydex Equal Weight Index fits perfectly into our overall investment approach; it allows us to be invested in the S&P 500 Index with a twist: Instead of directly investing in the S&P 500 Index, which is capital-weighted, RSP is equal-weighted.
Think of the House of Representatives vs. the Senate. In the House of Representatives, the number of representatives depends on the population of your state. This is how a capital-weighted index works. The larger capital stocks get a greater share of the overall allocation. Now compare that to the Senate, where no matter the population of your State, every State has two senators, therefore, the same amount of votes. That is the same as an equal-weighted index. Every stock gets the same vote, or weight, in this case.
We believe that capital weighting tends to overweight slower-growing and overpriced stocks; equal weighting does the exact opposite.
Year-to-date, the S&P 500 Index is up 7.71%, the Rydex S&P Equal Weighted Index Fund is up 11.97% (as of Oct. 27). In 2009 the S&P 500 Index was up over 26%; RSP was up over 44%. Over the 10 years ended in 2009, the S&P 500 was down 24.1% while the equal-weighted version of the S&P 500 was up 39.5%.
RSP also allows the investor who is looking for S&P 500 exposure to beat the index by being the index. By also analyzing the delta of RSP vs. the S&P 500, one can reduce their allocation to RSP during certain market cycles and get the same performance as the S&P 500. Last year the number was as much as a 30% reduction to RSP.
And it’s got the same holdings as SPY – just with 0.20% weights for each stock?
Correct; 0.20% per holding, rebalanced quarterly.
Tell us a little more about the area of U.S. stocks; what makes it your top pick?
We are seeing continued strength in U.S. equities, specifically the small- to mid-cap growth stocks. RSP allows us to capture the S&P 500 Index on an equal-weight basis; it is our belief that equal weighting allows you to capture more of the undervalued stocks in the S&P that have room to grow.
Are there alternative ETFs that could be used to capture the same theme? What makes this specific ETF your first choice?
There seems to be a new ETF every day; however, as far as equal weighting is concerned, there are less than 100 to choose from and they are normally very sector-specific, such as the Rydex S&P Equal Weight Utilities ETF (RYU).
RSP is our first choice because it is currently the only equal weighted S&P 500 Index ETF.
Since we’re talking about mid-caps, Russell Investments is rolling out a bunch of new indexes with equal weighting (and Rydex is planning 19 new ETFs based on them). Do you think this means that equal weighting is getting more of a foothold (though Russell still says the market-cap approach is "best way to truly reflect market segments")?
Equal weighting has outperformed the capital-weighted indices in times of recovery. The true advantage to the investor is by equal weighting they also avoid specific sector concentration and get a broader approach to the entire economy. On a capital-weighted basis, Energy and Technology dominate the top 10 holdings in the S&P 500. One sector, Technology, has done very well, as evidenced by the performance of Apple (AAPL), while Energy has been a laggard, as evidenced by Exxon (XOM). Guggenheim also announced they were going to bring out an equal-weighted Wilshire 5000, although we have not seen it yet.
Could the outsized returns be what could draw in investors from SPY, considering that RSP’s expense ratio is more than four times SPY’s (0.40% vs. 0.09%)?
I dont think enough people recognize that it can even be done. I would venture to say that 95% of the so-called financial advisers don’t know that there is a way to invest in the equal-weighted S&P 500.
If an investor wants to do it themselves, they can also easily do it via FolioFN. Pay the annual fee and rebalance commission-free.
How does your view on equities fit with the consensus?
The domestic equity market has not been a top performer in 2010, however, we believe that more investors/managers are now starting to invest a little heavier in the U.S. We were invested heavily in emerging/frontier markets and commodities in the first two quarters of 2010; in the third quarter we have begun to overweight domestic equities. We see continued growth in the asset class throughout the remainder of the year.
What catalysts, near-term or long-term, do you think could move the sector significantly?
We believe that QE2 and the Republican “Tidal Wave” in the House and Senate have been priced into the market. However, if a surprise is announced, we could see a significant pickup in the fourth quarter of 2010.
What could go wrong with your pick?
A stimulus backfire, a spike in unemployment or another geopolitical nightmare as we had in the beginning of this year.
And conversely, if large-caps outperform, then we could expect equal-weight ETFs to underperform market-cap-weighted issues like SPY? And if so, what’s your take on how long into a recovery smaller-cap stocks could be expected to lead the way?
During the last decade the only time that SPY was favored on a relative-strength basis over RSP was during the period of October 2007 thru April 2009. We choose to use this relationship change as a cautionary indicator as investors begin to flock to the larger, more defensive positions in the index. During that time frame, the maximum drawdown in RSP was a little over 45%, while SPY was slightly over 40%.
Thank you, Christian, for sharing your impressions with us.
Disclosure: Long RSP.
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Two ETFs to Play the Dollar’s Decline
November 2nd, 2010 | Posted by Global InvestorsThe Fed has hinted that it plans to purchase another round of long-term Treasuries next week in hopes that it will push rates lower and encourage lending and help revive the sagging economy. As with anything in the markets these days, there are ways to play the Fed’s moves with ETFs.
The worry for many U.S. investors is the future of the greenback, because more dollars in circulation dilutes the currency’s value, says Ben Baden for U.S. News & World Report.
Although the effects of quantitative easing will be keenly felt one way or another, investors can take steps to alleviate the impact on their portfolios.
The dollar remains the undisputed global reserve currency. Experts argue that it’s important to be diversified among currencies so that you’re protected if the dollar falls in value. Some ETFs (such as Rydex CurrencyShares) allow investors to invest in physical currencies, while others (such as WisdomTree) invest in non-U.S. money market securities or a combination of money market instruments to give exposure to non-U.S. money market securities or rates.
And then there’s the basket approach, with a an ETF such as the PowerShares DB G10 Currency Harvest (NYSEArca: DBV) which tracks currencies of the 10 developed countries that make up the G10. The fund uses the three-month interest rates of the G10 currencies and goes long on (makes a bet for) the three with the highest rates, and shorts (makes a bet against) the three with the lowest. It rebalances each quarter. Year-to-date, the fund is flat, and it returned more than 20 % in 2009.
Another option is the WisdomTree Emerging Currency Fund (NYSEArca: CEW), which tracks emerging market currencies, including the Brazilian real, Mexican peso, South African rand, Polish zloty and more.
Read the disclaimer; Tom Lydon is a board member of Rydex|SGI.
Tisha Guerrero contributed to this article.
Disclosure: None
Kellogg 401K Beats a 3 (But Not 4) Asset Class ETF Portfolio
November 2nd, 2010 | Posted by Global InvestorsKellogg Company (K) is an internationally recognized brand in the ready-to-eat cereal and convenience foods. Its principal products include cookies, crackers, toaster pastries, cereal bars, fruit snacks, frozen waffles, and veggie foods.
Kellogg Company sells its products in North America, Europe, Latin America, and the Asia Pacific. The company was founded in 1906 and is headquartered in Battle Creek, Michigan.
Its retirement plan is a reflection of the company — high quality funds but old style diversification. The 401K plan consists of 8 funds (not including cash). These funds give exposure to 3 major assets: US Equity, Foreign Equity, Fixed Income. The list of minor asset classes cove
| Asset Class | Ticker | Name |
|---|---|---|
| LARGE BLEND | SVSPX | SSgA S&P 500 Index |
| EQUITY | K | Kellogg |
| LARGE VALUE | VWNAX | Vanguard Windsor II Adm |
| LARGE GROWTH | PRGFX | T. Rowe Price Growth Stock |
| Foreign Large Blend | RERFX | American Funds EuroPacific Gr R5 |
| Small Growth | VEXRX | Vanguard Explorer Adm |
| SMALL VALUE | DFSVX | DFA U.S. Small Cap Value I |
| Intermediate-Term Bond | PTTRX | PIMCO Total Return Instl |
In summary
Having fewer US choices and more fixed income and international choices would provide better diversification, as would adding real estate or emerging markets.
Investing in the company’s own stock may show loyalty, but it may be better to leave that to an employee stock purchase plan if they have it.
Comparable ETFs
Equity: VTI, VT
Foreign Large Blend: EFA, VEU, GWL, PFA
Intermediate-term Bond: AGG, CIU, BIV, BND
Large Blend: IVV, IYY, IWV, VTI, VV, SPY, DLN, RSP, SCHX
Large Growth: IVW, IWZ, JKE, VUG, ELG, QQQQ, RPG, SCHG
Large Value: IVE, IWW, JKF, VTV, ELV, PWV, RPV, SCHV
Small Growth: IJT, IWO, JKK, VBK, DSG, PWT, RZG, UKK
Small Value: IJS, IWN, JKL, VBR, DSV, PWY, RZV, UVT
As of Oct 29, 2010, this plan investment choice is rated as average based on MyPlanIQ Plan Rating methodology that was designed to measure how effective a plan’s available investment funds are. It has the following detailed ratings:
Diversification — Rated as below average (13%)
Fund Quality — Rated as great (99%)
Portfolio Building — Rated as average (47%)
Overall Rating: average (53%)
The chart and table below show the historical performance of moderate model portfolios employing strategic and tactical asset allocation strategies (SAA and TAA, both provided by MyPlanIQ). For comparison purposes, we also include the moderate model portfolios of a typical 3 asset SIB (Simpler Is Better) plan. This SIB plan has the following candidate index funds and their ETFs equivalent:
US Equity: SPY or VTI
Foreign Equity: EFA or VEU
Fixed Income: AGG or BND
Performance chart (as of Oct 29, 2010)
Performance table (as of Oct 29, 2010)
| Portfolio Name | 1Yr AR | 1Yr Sharpe | 3Yr AR | 3Yr Sharpe | 5Yr AR | 5Yr Sharpe |
|---|---|---|---|---|---|---|
| Kellogg 401k Plan Tactical Asset Allocation Moderate | 7% | 57% | 4% | 44% | 9% | 83% |
| Kellogg 401k Plan Strategic Asset Allocation Moderate | 13% | 104% | 2% | 6% | 8% | 42% |
| Three Core Asset ETF Index Funds Tactical Asset Allocation Moderate | 0% | 1% | 1% | 10% | 5% | 46% |
| Three Core Asset ETF Index Funds Strategic Asset Allocation Moderate | 11% | 87% | -0% | -5% | 5% | 20% |
The Kellogg 401K plan beats the 3 core asset SIB based on the quality of the funds and the ability to select multiple funds in the US category.
If we now compare it with a four asset ETF SIB it is possible to see the benefit of having the extra asset class even without the benefit of multiple funds in each asset class.
Even with excellent choices of funds, the returns can be beaten by a simple ETF portfolio with an extra asset class.
Kellogg gets strong marks for the choice of funds but are encouraged to add another asset class (or two) to really provide additional returns to their employees.
Disclosure: No positions
Kellogg 401K Beats a 3 (But Not the 4) Asset Class ETF Portfolio
November 2nd, 2010 | Posted by Global InvestorsKellogg Company (K) is an internationally recognized brand in the ready-to-eat cereal and convenience foods. Its principal products include cookies, crackers, toaster pastries, cereal bars, fruit snacks, frozen waffles, and veggie foods.
Kellogg Company sells its products in North America, Europe, Latin America, and the Asia Pacific. The company was founded in 1906 and is headquartered in Battle Creek, Michigan.
Its retirement plan is a reflection of the company — high quality funds but old style diversification. The 401K plan consists of 8 funds (not including cash). These funds give exposure to 3 major assets: US Equity, Foreign Equity, Fixed Income. The list of minor asset classes cove
| Asset Class | Ticker | Name |
|---|---|---|
| LARGE BLEND | SVSPX | SSgA S&P 500 Index |
| EQUITY | K | Kellogg |
| LARGE VALUE | VWNAX | Vanguard Windsor II Adm |
| LARGE GROWTH | PRGFX | T. Rowe Price Growth Stock |
| Foreign Large Blend | RERFX | American Funds EuroPacific Gr R5 |
| Small Growth | VEXRX | Vanguard Explorer Adm |
| SMALL VALUE | DFSVX | DFA U.S. Small Cap Value I |
| Intermediate-Term Bond | PTTRX | PIMCO Total Return Instl |
In summary
Having fewer US choices and more fixed income and international choices would provide better diversification, as would adding real estate or emerging markets.
Investing in the company’s own stock may show loyalty, but it may be better to leave that to an employee stock purchase plan if they have it.
Comparable ETFs
Equity: VTI, VT
Foreign Large Blend: EFA, VEU, GWL, PFA
Intermediate-term Bond: AGG, CIU, BIV, BND
Large Blend: IVV, IYY, IWV, VTI, VV, SPY, DLN, RSP, SCHX
Large Growth: IVW, IWZ, JKE, VUG, ELG, QQQQ, RPG, SCHG
Large Value: IVE, IWW, JKF, VTV, ELV, PWV, RPV, SCHV
Small Growth: IJT, IWO, JKK, VBK, DSG, PWT, RZG, UKK
Small Value: IJS, IWN, JKL, VBR, DSV, PWY, RZV, UVT
As of Oct 29, 2010, this plan investment choice is rated as average based on MyPlanIQ Plan Rating methodology that was designed to measure how effective a plan’s available investment funds are. It has the following detailed ratings:
Diversification — Rated as below average (13%)
Fund Quality — Rated as great (99%)
Portfolio Building — Rated as average (47%)
Overall Rating: average (53%)
The chart and table below show the historical performance of moderate model portfolios employing strategic and tactical asset allocation strategies (SAA and TAA, both provided by MyPlanIQ). For comparison purposes, we also include the moderate model portfolios of a typical 3 asset SIB (Simpler Is Better) plan. This SIB plan has the following candidate index funds and their ETFs equivalent:
US Equity: SPY or VTI
Foreign Equity: EFA or VEU
Fixed Income: AGG or BND
Performance chart (as of Oct 29, 2010)
Performance table (as of Oct 29, 2010)
| Portfolio Name | 1Yr AR | 1Yr Sharpe | 3Yr AR | 3Yr Sharpe | 5Yr AR | 5Yr Sharpe |
|---|---|---|---|---|---|---|
| Kellogg 401k Plan Tactical Asset Allocation Moderate | 7% | 57% | 4% | 44% | 9% | 83% |
| Kellogg 401k Plan Strategic Asset Allocation Moderate | 13% | 104% | 2% | 6% | 8% | 42% |
| Three Core Asset ETF Index Funds Tactical Asset Allocation Moderate | 0% | 1% | 1% | 10% | 5% | 46% |
| Three Core Asset ETF Index Funds Strategic Asset Allocation Moderate | 11% | 87% | -0% | -5% | 5% | 20% |
The Kellogg 401K plan beats the 3 core asset SIB based on the quality of the funds and the ability to select multiple funds in the US category.
If we now compare it with a four asset ETF SIB it is possible to see the benefit of having the extra asset class even without the benefit of multiple funds in each asset class.
Even with excellent choices of funds, the returns can be beaten by a simple ETF portfolio with an extra asset class.
Kellogg gets strong marks for the choice of funds but are encouraged to add another asset class (or two) to really provide additional returns to their employees.
Disclosure: No positions
Teva Earnings Bring iShares Israel ETF Into Focus
November 2nd, 2010 | Posted by Global InvestorsMany of the world’s developed markets have struggled to return to solid levels of growth and have been weighed down by large budget deficits and high levels of unemployment. Due to this, many stock markets remain well below their 2008 lows, even when factoring in the large run-up in share prices over the past two months. Yet a few countries have managed to return to their pre-crash levels relatively quickly including the dynamic Israeli economy which has seen its fortunes boosted in recent months thanks to the discovery of a large gas field off of its coast in the Mediterranean. In fact, the Israeli Finance Minister recently said that the find could be worth “hundreds of billions of dollars” and some are projecting that the fields could help to double the surplus in the nation’s current accounts balance.
Besides this massive find in gas reserves, the Israeli economy has been humming along thanks to solid growth in the technology sector and improving fortunes for the country’s largest company, TEVA pharmaceuticals. TEVA is one of the world’s leaders in generic drug manufacturing and has managed to amass a market capitalization of over $46 billion which makes it one of the 20 largest drug companies in the world and by far the largest publicly traded company in Israel. Thanks to this size, investors who are bullish on Israel cannot overlook TEVA and its weight in the Israeli stock market, which is why today’s earnings report from the generic drug giant is so crucial.
TEVA is expected to post robust earnings for its most recent quarter with profits of $1.27 a share on revenues of $4.4 billion. Both of these numbers, if confirmed in today’s report, represent massive increases in year-over-year terms for the company; a 29.9% EPS growth and revenue growth of 23.1%. Of particular interest to investors should be a preliminary report on ratiopharm, Germany’s second largest generics producer which TEVA acquired earlier this year in order to beef up its business in Europe and become a larger player in the area. “Increasing Teva’s market share in Europe—a geography with tremendous potential for generics penetration—is an important pillar of our long-term growth strategy. With the acquisition of ratiopharm we will become the leader in key European markets and we are well-positioned to become the leader in many other European markets in the near future,” said Teva’s President and CEO Shlomo Yanai, suggesting that the nearly $5 billion dollar purchase by the Israeli giant is an important acquisition by the firm and that Europe will play a crucial role in their long-term growth strategy so any information regarding this is likely to weigh heavily on the stock.
Due to this earnings report, we have decided to make the iShares MSCI Israel Capped Investable Market Index Fund (EIS), which allocates just over one-fifth of its assets to TEVA, today’s ETF to watch. The fund tracks the MSCI Israel Capped Investable Market Index which measures the performance of the Israeli equity market and currently holds 81 securities in addition to its large holding in Teva. In terms of market capitalization breakdown, most of the fund goes towards mid cap securities (42.7%) while all of the giant cap allocation goes towards Teva. This suggests that Teva’s movements will have a large impact on the Israeli market and if the company should disappoint investors with its earnings report and forecasts for the rest of the year, we look for EIS to be in for a rough trading day.
Disclosure: No positions at time of writing.
Disclaimer: ETF Database is not an investment advisor, and any content published by ETF Database does not constitute individual investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. From time to time, issuers of exchange-traded products mentioned herein may place paid advertisements with ETF Database. All content on ETF Database is produced independently of any advertising relationships.
Emerging Markets: No Longer Cheap, So Why Are Investors Hot for Them?
November 2nd, 2010 | Posted by Global InvestorsDue to sluggish economic growth in the developed world and strong growth in emerging countries, investors are betting that emerging market equities will yield better returns. According to a story in the Journal:
In a recent report, Standard & Poor’s said that almost $50 billion flowed into emerging-markets equity funds this year through September, while $78 billion flowed out of developed-market funds, based on data from fund-flow tracker EPFR Global. In the week ended Oct. 6, emerging-markets equity funds attracted $6 billion, the largest weekly inflow in about three years.
Based on the trailing P/E ratio emerging market stocks are no longer cheap compared to U.S. stocks.
Click to enlarge:
Source: The Wall Street Journal
Vanguard analysts sometimes look at the price/earnings ratio for the MSCI Emerging Markets Index on a trailing basis. It suggests that valuations for U.S. and emerging-markets stocks have moved much more closely into alignment recently, compared with much lower relative valuations for emerging-markets stocks early in the decade.
As ETFs have become very popular, emerging market ETFs are attracting a large portion of the funds that investors are pouring into emerging stocks. Hence the asset base of two of the biggest emerging market ETFs continues to grow. In October alone, the Vanguard MSCI Emerging Markets ETF (VWO) attracted $3.22 billion in new assets. The iShares MSCI Emerging Markets Index Fund (EEM) collected $1.57 billion. The iShares ETF retains its position as the largest emerging-market fund with total assets of $48.0 billion as of November 1, 2010.
Disclosure: None
3 ETFs That Benefit From Manufacturing Growth in China
November 2nd, 2010 | Posted by Global InvestorsTwo weeks ago, China hiked interest rates for the first time in 3 years. Nobody had seen it coming. Up to that moment, investors believed that the country would not upset the world’s apple cart, even with its hot-running 9%-10% GDP.
Yet they did indeed raise rates on 10/19/2010. The People’s Bank probably felt that… with assets 30% higher than the summertime lows… it was time to cool the speculative appreciation of assets. (How ironic is it that China’s robust growth requires rate hikes, whereas anemic U.S. growth means a second round of quantitative easing?)
The implications of Chinese monetary tightening are (and were) straight-forward. Resource-related companies and resource-rich countries might not fare as well if they ship less materials to the mainland. Not surprisingly, shares of Brazil (EWZ), South Africa (EZA) and Australia (EWA) tumbled on 10/19/2010.
Two weeks later, on 11/1/2010, we can see why China raised rates in the first place. The country’s manufacturing growth actually accelerated in October. The recent data serves to confirm that the People’s Bank has its eye on the ball.
For investors, however, the correct call is a bit more challenging; specifically, manufacturing success in China may or may not be beneficial to materials exporters over the next few months. After all, doesn’t the acceleration in manufacturing increase the odds of additional China rate hikes?
It follows that I am less inclined to select China’s more obvious trading partners right now. I am more inclined to select Chinese industrial firms themselves as well as non-resource-related trading partners.
Here are 3 ETFs that benefit from manufacturing growth in China, even with the uncertainty surrounding future rate hikes:
1. iShares MSCI Singapore (EWS). One look at this fund’s holdings tells you most of what you need to know. The market-cap weighted index tracked by EWS has a 10% weighting in Oversea-China Banking Corporation. OCBC Bank is the second largest bank in Southeast Asia and was one of the only foreign banks with a branch presence in China in the 1950s, fostering brand name loyalty. Singaporean companies have invested tens of billions in China’s Guangdong, Shandong and Jiangsu provinces, particularly in telecommunications and electronic equipment manufacturing. Singapore Telecom is a top 10 holding.
2. iShares Taiwan (EWT). When I lived in Taiwan in the 1980s… a military take-over by China may have seemed remote, but hardly out of the realm of possibility. Today, the relationship is far less strained; trade pacts are commonplace; direct investment flows in both directions. What makes EWT a potential winner right now is the potential for an Internet boom on the mainland. To the extent social networking, gaming and video streaming continue to thrive in China, the information-technology heavy EWT (60%) should thrive as well.
3. Global X China Industrials (CHII). This one may not have the volume to get the kind of trade execution that I prefer. But hey… if it’s manufacturing success on the mainland, these are the very corporations that are producing things. CHII tracks an index that is designed to reflect industrial sector performance, from industrial equipment manufacturers to transporters (e.g., shipping, railway, etc.) to engineering firms.
Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.
Short-Term, High-Probability Mean Reversion Indicator: The Next Two Days Will Be Pivotal
November 2nd, 2010 | Posted by Global InvestorsAs I am sure all of you know by now, today is pivotal for the market. The elections and QE2 will be announced (QE2 might be Wednesday) and of course, everyone has their own opinion as to why the market should go up or down after the smoke has cleared. I think we are due for a correction, as indicated by my short positions in SPY and FXI. I also have a long position in TZA.
Unfortunately, I do not have a crystal ball. I will try and get back today with another post. Stay tuned.
Short-Term, High-Probability, Mean Reversion Indicator – as of close 11/01/10
Benchmark ETFs
Sector ETFs
International ETFs
Commodity ETFs
Ultra Extremes
Disclosure: Short SPY and FXI. Long TZA.
Short-Term, High-Probability Mean Reversion Indicator: The Next Two Days Will Be Pivotal
November 2nd, 2010 | Posted by Global InvestorsAs I am sure all of you know by now, today is pivotal for the market. The elections and QE2 will be announced (QE2 might be Wednesday) and of course, everyone has their own opinion as to why the market should go up or down after the smoke has cleared. I think we are due for a correction, as indicated by my short positions in SPY and FXI. I also have a long position in TZA.
Unfortunately, I do not have a crystal ball. I will try and get back today with another post. Stay tuned.
Short-Term, High-Probability, Mean Reversion Indicator – as of close 11/01/10
Benchmark ETFs
Sector ETFs
International ETFs
Commodity ETFs
Ultra Extremes
Disclosure: Short SPY and FXI. Long TZA.
VIX ETNs Don’t Perfectly Reflect Their Underlying Indices
November 1st, 2010 | Posted by Global InvestorsSophisticated investors want sophisticated ETFs that cater to their investment whims. But, volatility-related exchange traded notes (ETNs) that need a more acquired taste has come under some scrutiny as to the way the funds track the VIX.
First off, the volatility ETNs use VIX futures contracts, writes Clare White for Optionetics.
The iPath S&P 500 VIX Short-Term Futures ETN (VXX) holds front month and next month futures contracts. VXX has to roll out the contracts each month as the underlying securities mature. The front month contract percent weight diminishes to zero as the percent weight of the next month rises to 100%.
The iPath S&P 500 VIX Mid-Term Futures ETN (VXZ) holds futures contracts from months four to seven and also decreases the percent weight in the closest month while the expiration approaches for the front month contracts.
As of October 26, VXX held around 73% Nov. VIX Futures and 27% Dec. VIX futures. The logical way to compare changes in the VIX to VXX would be to calculate the percent change in the two futures holdings and add together. However, on the 27th, VIX rose by 2.42% while VXX increased 1.47%. Similarly, VXZ increased 0.09%, with a calculated component change of 0%.
One may argue that the discrepancy between the price of VXX and its underlying index is due to rolling front month contracts. But in doing so, the VIX daily change as compared to the VXX daily change should be positive, and again this is not always the case on a day-to-day bases, says White.
The daily change in the ETN’s component percent weights and the way the funds roll out contracts with higher or lower values will affect the ETN’s values. The change should be more evident in VXX as compared to VXZ since VXX only has two components and VIX futures tend term structure is more steep in the short-term.
Before investing in these ETNs, be sure to understand what they are created to do and that they fit with your investment goal.
Max Chen contributed to this article.
Disclosure: None
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