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ETFs To Safeguard Your Portfolio Against A Market Crash

Summary In the current highly dynamic and uncertain global market environment, many investors are looking for safe havens where they can place their money and have a restful sleep. Hedge funds might be suitable investment vehicles, as they are well-known for their focus on risk adjusted returns. Highland Capital Management recently launched three new ETFs tracking various hedge fund strategies, which might serve as a good enhancement of almost every investment portfolio’s statistics. Amid U.S. stock indices near historical highs, the slowing Chinese economy, geopolitical tensions between Russia and the Western world, Japan trying to revert the course of its economy by an unprecedented program of quantitative easing and the culminating Greek crisis, more and more investors are seeking absolute rather than alpha returns. Absolute returns are a domain of hedge funds that employ sophisticated strategies and advanced investment instruments in order to deliver positive returns, regardless of the market conditions. Hedge funds are often incorrectly compared with stocks and are often criticized for their underperformance during periods of strong equity markets growth. However, they are unappreciated by the majority of investors during times of pronounced market corrections and crashes, which is when they tend to suffer much smaller losses than stock indices do. The 2008 financial meltdown was not an exception. The graphs below capture relative performance of hedge funds represented by the HFRX Global Hedge Fund Index, actively managed open-end balanced UCITS compliant funds represented by the BAIF Open End Balanced Funds Index and a portfolio of bluechips represented by the S&P 500 Total Return Index. As you can see from the graphs, hedge funds and actively managed funds are considerably less volatile investments and can therefore serve as ideal investments for conservative investors who want to primarily protect their capital and avoid significant changes in value over time. Nevertheless, in the current highly dynamic and uncertain global market environment, absolute return products should also have a place in every medium risk investment portfolio. Not only do they perform better than short-dated government bonds and term deposits, but thanks to low correlation with other asset classes and comparatively high risk adjusted returns, they also improve general statistics of almost any investment portfolio. Moreover, investments into hedge funds are no longer available solely for high-net-worth individuals. Thanks to ETFs, there is basically no minimal investment and lock-up periods are not an issue. Besides the largest and most liquid ETF tracking overall hedge funds performance – the IQ Hedge Multi-Strategy Tracker ETF (NYSEARCA: QAI ) – three new hedge funds replicating ETFs recently came to market. The first of them, The Highland HFR Global ETF (NYSEARCA: HHFR ), similarly to QAI, tries to mimic the performance of traditional multi-strategy hedge funds that incorporate fixed income and shorting as well as long equity positions. Hence, we could suppose high correlation with QAI. However, after taking a closer look at top holdings of both funds, serious doubts about the similarity arise. QAI’s Top Ten Holdings Name & Ticker Weight (%) Vanguard Total Bond Market Index Fund (NYSEARCA: BND ) 19.13 SPDR Barclays Convertible Securities ETF (NYSEARCA: CWB ) 18.19 iShares Core U.S. Aggregate Bond ETF (NYSEARCA: AGG ) 17.77 iShares iBoxx USD Investment Grade Corporate Bond ETF (NYSEARCA: LQD ) -11.05 Vanguard Short Term Bond Index Fund ETF (NYSEARCA: BSV ) 9.01 PowerShares Senior Loan Portfolio (NYSEARCA: BKLN ) 8.67 iShares Russell 2000 Growth ETF (NYSEARCA: IWO ) 6.46 PowerShares DB G10 Currency Harvest Fund (NYSEARCA: DBV ) 4.84 iShares 1-3 Year Treasury Bond ETF (NYSEARCA: SHY ) 4.42 iShares Russell 2000 Value ETF (NYSEARCA: IWN ) -4.31 Data Source: QAI’s latest Fact Sheet Note: Minus before weight means short position HHFR’s Top Ten Holdings Name & Ticker Weight (%) LinkedIn Corp (NYSE: LNKD ) 3.58 R.R. Donnelley & Sons Co (NASDAQ: RRD ) 3.43 Sungard Data Systems 3.04 Kinetics Concept 3.03 Hertz Corp (NYSE: HTZ ) 3.03 Chrysler (Pending: CGC ) 3.02 Allergan Inc (NYSE: AGN ) 3.02 Univision Comm 3.01 First Data Corp (Pending: FDATA ) 3.00 DirectTV (NASDAQ: DTV ) 2.59 Data Source: HHFR’s website While more than a half of QAI’s holdings are bond ETFs, Highland Capital Management’s HHFR actually consists mostly of equities. The other two funds track different hedge fund strategies. The Highland HFR Equity Hedge ETF (NYSEARCA: HHDG ) consists of traditional hedged equity strategies that can both go long and go short on selected securities. And the last one, the Highland HFR Event-Driven ETF (NYSEARCA: DRVN ), capitalizes on a discipline in the hedge fund community that takes advantage of pending corporate events or other near-term catalysts for revaluation, albeit upward or downward. Despite the post-crisis run-up on global equity markets, I think investors should thoroughly consider how their portfolios will thrive in the upcoming years. Now might be the perfect time to hedge long-only portfolios a little bit. Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in QAI over the next 72 hours. (More…) 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.

Spain Is The Next Greece – Avoid EWP

Summary A political push is underway in Spain that appears to me to have a lot in common with Syriza’s rise to power in Greece. Leftist politicians have won a majority of Spain’s municipal elections and taken control of key cities including Madrid and Barcelona, and they have their eyes on national control. If Spain is going to be the next Greece, then its future actions and direction are not likely to sit well with its Eurogroup partners. The investment community is likely to see this as “contagion,” and that does not bode well for the euro, European equities, and judging by the developments in Greece, Spanish equities. Thus, no matter what happens between Greece and its creditors, it would seem wise to avoid Spanish stocks and the iShares MSCI Spain Capped ETF. Some pundits believe that any sort of closure for the Greece issue is a plus for Europe, whether Greece stays in the eurozone or leaves it. But there is one European market sector that I do not see a positive outlook for either way. Spain looks to be the next Greece because of a political circumstance similar to what occurred in Greece before the current crisis heated up. Thus, I suggest investors sell the iShares MSCI Spain Capped ETF (NYSE: EWP ) and Spanish stocks generally. A succession of leftist political victories in Spain too closely resembles what happened in Greece before it raised issue with its creditors. I believe it will lead to division between Spain (perhaps emboldened now by Greece’s display of strength) and more progressive economies to the North. While Spain is not in the same situation as Greece, its political policies and direction moving forward are likely to trouble investors. Before Syriza, a decidedly left wing party, was elected into power in Greece, everything seemed to be improving, at least from our perspective over here. The economy was growing and the budget was operating at a surplus. Yes, there was still extremely high unemployment and unbearable taxation for a people suffering in strife, but from the perspective of those on the outside Greece was doing better. It was, in the end, the pain and suffering of the people that allowed the political candidate (Tsipras) calling for an end to austerity to overcome the reigning government’s plea for patience. Guess what’s happening in Spain today? The Leftists are Coming! This month, a wave of leftists (not my description) won victories in municipal elections across Spain. The political push in Spain sure resembles the same movement that took control of Greece and led Europe and relative investors into today’s turmoil. In the comment section of the article I linked to here, the first comment says something like, “This must be the Greek contagion they were all afraid of. This won’t end well.” I agree, but would add, this won’t end well for European stocks and debt and the euro, and especially Spanish equities. The newly elected municipal leaders in Spain easily overcame their predecessors with popular campaign pleas. For instance, one new mayor is working to put the victims of foreclosure (that’s how they see it) into homes foreclosed upon and held by banks. Back in Greece, Syriza won with promises to hire back laid-off public sector workers, reduce taxes and to restore old pension norms. But what the so-called leftists in Greece and Spain will have in common is an aversion to German inspired austere budgeting. So then the leftists in Spain are likely to cause a fuss, and I suspect they’ll stare their national intentions now that the Greeks are on the marquee. Opportunistic politicians with plans to take control of Spain this year should find opportunity now to organize gatherings in support of the Greek people. I would be surprised if it doesn’t happen. It will draw global investor attention to the contagion they all feared might spread across the PIIGS (Portugal, Italy, Greece, Spain – I’ll leave out Ireland) of the eurozone periphery. And when the leftists unseat the ruling power atop the Prime Ministry in Spain this year as I expect, we will all have to take note. 10-Year Chart of EWP at Seeking Alpha Just like it played out for Greece, none of this weighs well for Spanish stocks. It portends rather that this 10-year chart of the iShares MSCI Spain Capped ETF , which seems to show stocks going up and down before ending up at the same place, will continue to do so while sporting a new leg lower. Indeed, EWP was one of the poorest performers of the eurozone on Monday, as this secret seems to be leaking. EWP fell 5.2% on Monday, while the iShares Europe ETF (NYSE: IEV ) dropped just 3.4% and the iShares MSCI Germany ETF (NYSE: EWG ) fell 4.0%. The Global X FTSE Greece 20 ETF (NYSE: GREK ) fell 19.4%, since it was the star of the show. Take note that the German ETF was doing quite well this year, but EWP had a negative year-to-date performance record heading into the black day for Europe. Things just got worse for Spain. The political change overtaking Europe is a problem for the euro, but the Swiss National Bank (SNB) and the European Central Bank (ECB) have managed to manipulate the currency well enough to turn a 1.9% overnight loss into a sharp gain by Monday afternoon. The SNB flooded the market with Swiss francs (the safe haven for capital running from the euro at the time) to weaken the franc unnaturally against the euro and support stability (or illusion) in Europe. It’s going to get harder to hide this mess, though, when the Spaniards hit the streets in solidarity with Greece or when these new party candidates win national elections. I found a CNBC report interesting today, as I watched Sarah Eisen report that currency traders believe the euro has not yet given way because of no sign of Greek contagion. Well, I agree but I’m saying that is exactly what is about to change. So, friends, I would keep this in mind when venturing investments in European shares and especially when considering the iShares MSCI Spain Capped ETF, which I would avoid. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) 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.

Why The Best-Performing ETF Isn’t Always The Best Choice

By Andy Rachleff We get a lot of questions about why we choose certain exchange-traded funds in our portfolios and not others. Often, readers of our blog will point out that this or that ETF has outperformed one of the ETFs we recommend for our portfolios. We love getting feedback, but in this case, our readers are failing to see the forest for the trees. Specifically, they’re evaluating things in isolation, when what matters is how a particular ETF works in a portfolio. Sports fans know this idea well. Teams will sign players with superstar statistics, only to see their overall team performance suffer, as the player doesn’t mesh well with others. Conversely, teams may add role players, only to see their team overall performance soar. The same is true in portfolios: What matters is not just the returns of an individual ETF, but its relationship to the other funds in the portfolio. When Is A Hot Performing Fund A Bad Idea? When you construct a portfolio using Modern Portfolio Theory, you’re required to estimate three things: The expected returns of each asset class in the portfolio. The expected volatility of each asset class in the portfolio. The correlations between each asset class in the portfolio. Let’s imagine you have two portfolios, each of which owns 4 funds. Portfolio 1 holds funds A, B, C and D, while Portfolio 2 holds funds A, B, C and E. Over a one-year time period, we expect to see the following returns and volatility for each fund. (click to enlarge) As a stand-alone investment for a risk-tolerant investor, fund D appears very attractive: It has the highest expected return. But you also have to consider volatility and correlations when determining which ETFs will maximize the risk adjusted return for the overall portfolio. In this case fund D is reasonably correlated to the other funds, whereas fund E is entirely uncorrelated. It marches to its own drummer. (click to enlarge) If you run these portfolios through an optimizer, it will spit out the mix of assets that maximizes the portfolio’s return for every level of risk/volatility. The graph below displays the expected return at every level of risk for three different portfolios: One with just funds A, B and C (red line), one with A, B, C and Fund D (green line) and one with A, B, C and Fund E (blue line). In every case, the portfolio containing Fund E delivers more return per unit of risk than the competing portfolios – despite the fact that Fund D has a higher expected return than Fund E. (click to enlarge) The only case that can be made for the portfolio containing fund D is for investors that are extraordinarily risk-tolerant and searching out the highest absolute return. But even portfolios that are nearly 100% concentrated in fund D barely outperform our A/B/C/E portfolio (and certainly fail on a risk-adjusted basis). At Wealthfront, we evaluate ETFs in the context of their position in a portfolio. That places extra emphasis on funds with low correlations to other funds, and funds that can deliver consistent strong risk-adjusted returns. In a future post, we’ll discuss why we generally favor Vanguard ETFs over their competitors. But even with our overall predilection for Vanguard products, the important thing is the same: All selections must be made in the context of an overall portfolio. Even if that means you leave a hot-performer by the wayside. Disclosure The information provided here is for educational purposes only. Nothing in this article should be construed as a tax advice, solicitation or offer, or recommendation, to buy or sell any security. There is a potential for loss as well as gain. Actual investors on Wealthfront may experience different results from the results shown. Past performance is no guarantee of future results. Andy is Wealthfront’s co-founder and its first CEO. He is now serving as Chairman of Wealthfront’s board and company Ambassador. A co-founder and former General Partner of venture capital firm Benchmark Capital, Andy is on the faculty of the Stanford Graduate School of Business, where he teaches a variety of courses on technology entrepreneurship. He also serves on the Board of Trustees of the University of Pennsylvania and is the Vice Chairman of their endowment investment committee. Andy earned his BS from the University of Pennsylvania and his M.B.A. from Stanford Graduate School of Business.