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Build Your Own Leveraged ETF (ETRACS Edition)

Summary A previous article showed that the ETRACS 2x ETNs did not inexorably decay in value even over several years. Other authors have investigated the idea of using leveraged funds to build your own ETF. The application of this strategy to the ETRACS 2x ETNs are investigated, revealing the potential for additional yield. Introduction The ETRACS line-up of ETNs issued by UBS (NYSE: UBS ) provides investors with exposure to a broad range of investment classes. A number of the ETRACS ETNs are 2x leveraged, which means that they seek to return twice the total return of the underlying index, minus fees. This allows the ETNs to offer alluring headline yields, making them attractive for income investors. Additionally, some of these funds pay monthly distributions, although these can be lumpy. A recent article provides an overview of the types, yields and expense ratios of these 2x leveraged ETNs. An interesting feature of the 2X leveraged ETNs is that their leverage resets monthly rather than daily, which is the norm for most leveraged funds on the market. It is known that decay or slippage in leveraged funds will occur when the underlying index is volatile with no net change over a period of time. By resetting monthly rather than daily, this decay can be somewhat mitigated. An article by Seeking Alpha author Dane Van Domelen addresses the decay issue mathematically and shows that in most cases, the decay is not as serious as is often thought. However, this leverage does not come without costs. There is the management cost associated with providing the ETN, as well as a finance cost associated with maintaining the 2x leverage. Finally, it should be noted that investors in ETNs are subject to credit risk from the fund sponsor, in this case UBS. If UBS were to go bankrupt, the ETNs will likely become worthless. However, Professor Lance Brofman has argued that the risk of ETN investors losing money due to UBS going bankrupt is, barring an overnight collapse, minimal because the notes can always be redeemed at net asset value. I recently studied the performance of several of the 2x leveraged ETNs and found that, in general, the 2x ETNs fulfilled their objectives and also outperformed the corresponding (hypothetical) daily-reset 2x ETNs. This suggests that, over the last few years at least, that the 2x ETNs have been suitable (insofar as them being able to meet their objectives vis-a-vis their 1x counterparts) long-term instruments for the leverage-seeking investor. Just to make this point crystal clear, the 2x ETRACS ETNs have allowed aggressive investors to obtain 2x participation in a variety of asset classes in an efficient and stable manner – both to the upside and to the downside – I am not making specific recommendations as to whether the asset classes themselves (e.g. mREITs, MLPs, BDCs, and CEFs, just to name a few of the asset types covered by the ETRACS) are suitable as long-term investments. Building your own ETF In another article entitled ” Build Your Own Leveraged ETF “, Dane Van Domelen explores the possibility of combining leveraged ETFs with cash or other funds for various purposes. For example, Dane posited that a one-third ProShares UltraPro S&P 500 ETF (NYSEARCA: UPRO ), a 3x leveraged version of the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ), two-thirds cash portfolio has virtually the same properties as a 100% S&P 500 portfolio (with periodic rebalancing), but allows you to hold a lot of cash: An interesting special case is where you put one-third of your money in UPRO and two-thirds in cash. At the onset, this portfolio would behave almost exactly as if you had all of your money in the S&P 500. UPRO’s expense ratio should result in somewhat diminished returns, but not much. And it might be worth it to free up two-thirds of your money, for emergencies and so forth. UBS 2x ETN expert Lance Brofman has also considered the same idea : If this hypothetical investor were thinking of either investing $1,000 of his $10,000 in the UBS ETRACS 2X Leveraged Long Wells Fargo Business Development Company ETN ( BDCL) and keeping $9,000 in the money market fund, or investing $2,000 of his $10,000 in the UBS ETRACS Wells Fargo Business Development Company ETN ( BDCS) and keeping $8,000 in the money market fund, either choice would entail the same amount of risk and potential capital gain. This is because BDCL, being 2X leveraged, would be expected to move either way twice as much as a basket of Business Development Companies, while BDCS would move in line with a basket of Business Development Companies. This article seeks to analyze whether it is possible to “build your own ETF” with the suite of UBS 2x leveraged ETNs, by applying the strategy described above by Dane Van Domelen and Lance Brofman. Interestingly, the analysis reveals the potential to add on additional yield to your portfolio. Considering fees The fee required to maintain the 2x leverage of the ETRACS 2x ETNs is based on the 3-month LIBOR, which currently stands at 0.33%. This is added to a variable financing spread (0.40-1.00%) to generate a total financing rate that is passed on to investors. This total financing rate of 0.77-1.33% is much lower than is available for all but the wealthiest of individual investors. Lance Brofman writes : Many retail investors cannot borrow at interest rates low enough to make buying BDCS on margin a better proposition than buying BDCL. This means that from an interest point of view, it would usually be better to buy the leveraged fund than to try and replicate it yourself with a margin loan from your broker. Applying the strategy However, what if the investor wasn’t interested in using leverage in the first place? Can he still make use of the low financing rates charged by the ETRACS 2x ETNs? To explore this, let’s try to apply the strategy described above by Dane Van Domelen and Lance Brofman, which basically entails replicating a 100% investment in a 1x fund with a 50% investment in the corresponding 2x fund and a 50% allocation to cash or a risk-free asset. The following illustrates such an example. Example Let’s say that you had $10K invested in the SPDR Dividend ETF (NYSEARCA: SDY ). SDY charges 0.35% in expenses, which comes out to $35 per year. You could replicate that investment with $5K in the UBS ETRACS Monthly Pay 2x Leveraged S&P Dividend ETN (NYSEARCA: SDYL ), leaving yourself with $5K in cash. SDYL charges 1.01% in total expenses, which on $5K comes out to $50.50. In other words, you’d be paying an extra $15.50 per year if you decided to invest $5K in SDYL compared to $10K in SDY. But wait! You have an extra $5K in cash left over. If you can use that $5K to earn $15.50 per year, corresponding to a rate of return [RR] of 0.31%, you can break even. With any higher rate of return, you would benefit from using the leveraged ETN and investing the rest of your cash. At first glance, it seems that 0.31% is a ridiculously low hurdle to surpass, suggesting that one would nearly always benefit from using the leveraged ETNs and investing the rest of the cash. However, one also needs to consider the risk of the invested cash portion. To mimic, as closely as possible, the risk of the original scenario (i.e. $10K invested in SDY), the $5K cash left over after investing $5K in SDYL should be invested in as risk-free of an asset as possible. Bankrate.com shows that 1.30% 1-year CDs and 1.25% savings accounts are currently available. These investments are insured by the FDIC, and can be considered to be nearly risk-free. Using the above example, investing $5K at 1.30% for one year yields you $65.00. After subtracting the additional $15.5 required for the additional expenses of SDYL ($50.50) vs. SDY ($35), you’d gain $49.50, or an additional 0.495%, from using this strategy! Results The following table shows a list of 2x leveraged ETNs, their corresponding 1x fund, and their respective total expense ratios [TER]. Also shown is the rate of return [RR] required on the risk-free portion to break-even, as well as additional yield that you would be able to obtain on the entire portfolio had the risk-free portion been left in cash paying 0%, a savings account paying 1.25% or a 1-year CD paying 1.30%. A negative number indicates that this strategy would lose money relative to investing the whole portion in the 1x fund. The funds are arranged in descending order of required RR on the risk-free portion. Please see my previous article if further information is required regarding these 2x ETNs. Note that some funds such as the ETRACS Monthly Pay 2xLeveraged US High Dividend Low Volatility ETN (NYSEARCA: HDLV ) and the ETRACS Monthly Pay 2xLeveraged U.S. Small Cap High Dividend ETN (NYSEARCA: SMHD ) so not have corresponding 1x counterparts, so are excluded from this analysis. Ticker TER Ticker TER Required RR Cash (0%) Savings (1.25%) 1-year CD (1.30%) ETRACS Monthly Pay 2xLeveraged MSCI US REIT Index ETN (NYSEARCA: LRET ) 1.96% Vanguard REIT Index ETF (NYSEARCA: VNQ ) 0.10% 1.76% -0.88% -0.26% -0.23% UBS ETRACS Monthly Reset 2xLeveraged S&P 500 total Return ETN (NYSEARCA: SPLX ) 1.56% SPY 0.09% 1.38% -0.69% -0.07% -0.04% ETRACS Monthly Reset 2xLeveraged ISE Exclusively Homebuilders ETN (NYSEARCA: HOML ) 1.96% ETRACS ISE Exclusively Homebuilders ETN (NYSEARCA: HOMX ) 0.40% 1.16% -0.58% 0.05% 0.07% ETRACS 2xMonthly Leveraged S&P MLP Index ETN (NYSEARCA: MLPV ) 2.26% iPath S&P MLP ETN (NYSEARCA: IMLP ) 0.80% 0.66% -0.33% 0.30% 0.32% SDYL 1.01% SDY 0.35% 0.31% -0.16% 0.47% 0.50% UBS ETRACS Monthly Pay 2x Leveraged Mortgage REIT ETN (NYSEARCA: MORL ) 1.11% Market Vectors Mortgage REIT Income ETF (NYSEARCA: MORT ) 0.41% 0.29% -0.15% 0.48% 0.51% UBS ETRACS Monthly Pay 2x Leveraged Dow Jones Select Dividend Index ETN (NYSEARCA: DVYL ) 1.06% iShares Select Dividend ETF (NYSEARCA: DVY ) 0.39% 0.28% -0.14% 0.49% 0.51% UBS ETRACS Monthly Pay 2xLeveraged Closed-End Fund ETN (NYSEARCA: CEFL ) 1.21% YieldShares High Income ETF (NYSEARCA: YYY ) 0.50% 0.21% -0.11% 0.52% 0.55% UBS ETRACS Monthly Pay 2X Leveraged Dow Jones International Real Estate ETN (NYSEARCA: RWXL ) 1.31% SPDR Dow Jones International Real Estate ETF (NYSEARCA: RWX ) 0.59% 0.13% -0.07% 0.56% 0.59% UBS ETRACS Monthly Pay 2xLeveraged Wells Fargo MLP Ex – Energy ETN (NYSEARCA: LMLP ) 1.76% UBS ETRACS Wells Fargo MLP Ex-Energy ETN (NYSEARCA: FMLP ) 0.85% 0.06% -0.03% 0.60% 0.62% UBS ETRACS Monthly Pay 2xLeveraged Diversified High Income ETN (NYSEARCA: DVHL ) 1.56% UBS ETRACS Diversified High Income ETN (NYSEARCA: DVHI ) 0.84% -0.12% 0.06% 0.69% 0.71% UBS ETRACS 2x Leveraged Long Alerian MLP Infrastructure Index ETN (NYSEARCA: MLPL ) 1.16% UBS ETRACS Alerian MLP Infrastructure Index ETN (NYSEARCA: MLPI ) 0.85% -0.54% 0.27% 0.90% 0.92% BDCL 1.16% BDCS 0.85% -0.54% 0.27% 0.90% 0.92% From the table above, we can see that the LRET/VNQ combination would be the worst pair to implement this strategy with, as it requires a 1.76% RR to break even. This means that even with a 1-year CD rate of 1.30%, you would be losing -0.23% using this method. This can be attributed to LRET’s exceptionally high expense ratio of 1.96%, and VNQ’s exceptionally low expense ratio of 0.10%, making it highly expensive to replicate 100% VNQ with 50% LRET. At the other end of the spectrum, the BDCL/BDCS combination appears to be the best pair for this strategy. The required RR is negative 0.54%, meaning that even if you left the 50% risk-free portion in cash, you would be gaining 0.27% on your overall portfolio. Investing the risk-free portion is a 1-year CD improves the performance of the portfolio by 0.92%. This can be attributed to BDCL’s below-average expense ratio of 1.16% and BDCS’ above-average expense ratio of 0.85%. The following chart shows the required RR for the 2x funds in order to implement this strategy. The following chart shows the additional yield that can be harvested by investing the 50% risk-free portion in cash (0%), a savings account (1.25%) or a 1-year CD (1.30%) for the respective 2x funds. Risks and limitations The 50% investment in a 2x fund may not correspond exactly to a 100% investment in 1x fund. It may do better or it may do worse. Periodic rebalancing may help, but this would entail additional transaction fees. In the case where the 1x fund is an ETF, you are additionally exposed to the credit risk of UBS when it is substituted for a 2x ETN (see introduction). In the case where the 1x fund is an ETF, the tax treatment may change when it is substituted for a 2x ETN. Savings accounts and CDs are only FDIC-insured up to a certain value (though if we’re worrying about this we have much bigger problems on our hands than the implementation of this strategy!). Conclusion A previous article showed that the ETRACS 2x ETNs did not inexorably decay in value even over several years, suggesting that the funds can function as efficient long-term investments for the leverage-seeking investor. This article shows that an investor not interested in leverage could still potentially benefit from the ETRACS 2x funds by “building his own ETF”. This simply costs of replicating a 100% investment in a 1x fund with a 50% investment in the corresponding 2x fund, and a 50% investment in a risk-free asset. Additional yields of up to 0.92% per year are available using this strategy. Further enhancements in yields can be achieved by investing the 50% into more risky assets such as corporate bonds, although this alters the overall risk-reward dynamics of the strategy.

MORT And MORL Weighed Down By Smaller MREITs In 2015

Summary Despite their high yields, MORL and MORT have recorded negative total return performances in 2015. Surprisingly, the top 7 holdings of the fund all posted better YTD returns than the index. A number of smaller mREITs have fallen > 20% this year and may offer attractive entry points for the aggressive investor. Investors in the Market Vectors Mortgage REIT Income ETF (NYSEARCA: MORT ) and the 2x leveraged version, the UBS ETRACS 2x Leveraged Mortgage REIT ETN (NYSEARCA: MORL ), have not had a good year so far. Despite a recent rally triggered by the Fed’s decision not to raise interest rates, MORT is still down by -5.39% year-to-date [YTD], while MORL is down -12.5%. The iShares Mortgage Real Estate Capped (NYSEARCA: REM ), an ETF that tracks a different index than MORT/MORL, has performed slightly better at -4.00% for the year. MORL Total Return Price data by YCharts As an investor in MORL, I wanted to find out why the fund was doing so poorly. I first checked the YTD performance of Annaly Capital (NYSE: NLY ) and American Capital Agency (NASDAQ: AGNC ), the two largest constituents of MORT/MORL that together constitute nearly 25% of the index. However, neither stock has done as poorly as MORT. NLY has eked out a positive return of 1.89% in 2015, while AGNC is down by -3.41%. NLY Total Return Price data by YCharts I then checked the performance of the five next-largest constituents of MORT/MORL. Surprisingly, these five stocks have also all outperformed MORT. New Residential Investment Corp (NYSE: NRZ ) leads the pack with a YTD total return performance of +19.46%. STWD Total Return Price data by YCharts Summarizing the observations so far, the seven-largest holdings of MORL/MORT, which account for over half of the fund, have all outperformed the index. This suggests that the remaining constituents of the index have underperformed. To investigate this further, I obtained the weightings and YTD performance data of the 24 constituents of MORT/MORL from Morningstar . Note that the total return data may differ slightly from the YCharts graphs above. For the rest of the article, the Morningstar data will be used. Company Ticker % Assets YTD return / % Annaly Capital Management Inc NLY 14.70% 1.94% American Capital Agency Corp AGNC 10.21% -3.23% Starwood Property Trust Inc STWD 6.20% -2.28% New Residential Investment Corp NRZ 5.40% 22.32% Chimera Investment Corp CIM 5.37% -3.58% Two Harbors Investment Corp TWO 5.24% -0.10% Blackstone Mortgage Trust Inc BXMT 5.22% 3.47% Mfa Financial Inc MFA 4.42% -5.26% Hatteras Financial Corp HTS 4.36% -6.78% Colony Financial Inc CLNY 4.33% -5.00% Invesco Mortgage Capital Inc IVR 4.22% -6.14% Cypress Sharpridge Investments Inc CYS 3.95% -3.90% Pennymac Mortgage Investment Trust PMT 3.75% -17.88% Capstead Mortgage Corp CMO 3.12% -9.93% Apollo Commercial Real Estate Finance I ARI 3.02% 7.70% Armour Residential Reit Inc ARR 2.83% -21.81% American Capital Mortgage Investment MTGE 2.58% -6.61% New York Mortgage Trust Inc NYMT 2.58% -12.05% Redwood Trust Inc RWT 2.24% -20.96% Anworth Mortgage Asset Corp ANH 1.57% 2.86% Resource Capital Corp RSO 1.46% -27.83% Rait Financial Trust RAS 1.26% -22.82% Dynex Capital Inc DX 1.15% -14.79% Newcastle Investment Corp NCT 0.98% 13.59% The results above confirm my initial suspicion. While the top 7 holdings in the index (together accounting for over 52% of assets) had an average YTD performance of +2.65%, the remaining 17 constituents had an average performance of -9.27%. The data above is also shown in graphical form. There is weak positive correlation between % assets and % YTD return, indicating that the largest mREITs have outperformed the smaller mREITs so far this year. (The index uses a cap-weighted methodology, meaning that mREITs with a greater weighting in the index have larger market caps). The data is also shown in bar chart form below. We can see that most of the worst-performing mREITs lie on the right hand side of the chart, i.e. the big losers have all been smaller-cap mREITs. A notable exception is NCT, which is the smallest holding in the index but recorded a +13.59% YTD gain. Implications for investors What does this mean for mREIT investors? Firstly, we can see that there is a very wide dispersion in YTD return performances. NRZ has the best total return performance of +22.32%, while RSO has had the worst total return performance of -27.83%. However, past performance is no guarantee of future results, and investors uncomfortable with picking individual mREIT names may still prefer to remain diversified by investing in MORT/MORL. MORT has a trailing 12-months [TTM] yield of 11.07% and MORL has a TTM yield of 29.23%. Secondly, it is unclear whether the outperformance of large-cap mREITs vs. their small-cap brethren will persist into the future. The constant jitters and palpitations over a potential rate hike in 2015 may have unfairly punished small-cap mREITs, which are probably deemed to be more risky and volatile compared to their larger peers. However, this is just my rough guess, and more knowledgeable mREIT investors may have a better answer to this conundrum. A full analysis of the effect of interest rates on the performance of each mREIT is beyond the scope of this article. Finally, I hope that investors who are comfortable with selecting individual mREITs may still find the data useful. With further potential interest rate turmoil ahead, does one stick with the industry bellwethers NLY and AGNC which have weathered the storm so far in 2015? Or does one go bottom fishing with small-cap mREITs such as ARR, RWT, RSO and RAS that have all fallen more than 20% YTD, with the hopes of a rebound? The answer will depend on each investor’s risk appetite and interest rate outlook. Disclosure: I am/we are long MORL. (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.

ALFA: A Market-Beating ETF About To Go Market-Neutral

Summary ALFA allows the retail investor to “invest with the best”. ALFA has shown market-beating performances since inception, with superior upside and downside capture ratios, but also higher volatility. Barring a final-day rally, ALFA is about to go into market-neutral mode. The AlphaClone Alternative Alpha ETF (NYSEARCA: ALFA ) is an ETF that tracks the AlphaClone Hedge Fund Long/Short Index. This index contains U.S.-listed equity securities to which hedge funds and institutional investors have disclosed significant exposure. An interesting feature of the index is that it uses AlphaClone’s proprietary “Clone Score” methodology to aggregate the ideas of hedge funds for which historically it has made the most sense to follow based on their disclosures. Additionally, index constituents are equal weighted but have an overlap bias (i.e., securities held by twice the number of managers have twice the weight). In a recent article entitled ” The AlphaClone Alternative Alpha ETF May Be The Safest Equity Ticker ,” Seeking Alpha author Fred Piard elegantly summarizes the methodology of ALFA as thus: ALFA selects fund managers based on their past performances after publication of their holdings…In other words, past performances must be good, and also replicable. Investing in ALFA therefore allows the retail investor to “invest with the best” (while avoiding 2 and 20 fee structure associated with investing in hedge funds). Only holdings from top managers are chosen for inclusion in the index – holdings from mediocre managers are not considered. ALFA was incepted in May 2012, and charges an expense ratio of 0.95%. Another hedge fund-duplicating ETF is the Global X Guru Index ETF (NYSEARCA: GURU ). Performance The following chart shows the total return performance of ALFA and the U.S. market (NYSEARCA: SPY ) since inception of ALFA. ALFA Total Return Price data by YCharts We can see from the chart above that ALFA has pretty much led SPY wire-to-wire since inception. However, the higher return of ALFA has been accompanied by higher volatility. The following chart shows the 3-year annualized standard deviation (volatility), return, Sharpe and Sortino ratios for ALFA and SPY (source: Morningstar ). We can see from the above chart that ALFA has been about 30% more volatile than SPY over the past three years. This has led to ALFA’s Sharpe ratio of 1.78 being lower than SPY’s at 1.93. Interestingly, however, the Sortino ratio, which unlike Sharpe ratio only takes into account downside (and not upside) volatility, slightly favors ALFA at 4.36 vs. SPY at 4.26. This is consistent with ALFA’s impressive upside and downside capture ratios over the past 1 and 3-year periods, as shown in the chart below (source: Morningstar ). The chart above shows that over the past 3 years, ALFA has managed to return an extra 7% over the S&P 500 in positive months for the market, while decreasing 18% less than the S&P 500 in negative months for the market. Its 1-year upside and downside capture ratios are even more impressive, at 130% and 52% respectively. Obviously, SPY captures 100% of both the upside and downside of the S&P 500. Additionally, ALFA has had a 0.84 correlation with SPY since inception (source: InvestSpy ). Holdings The higher volatility of ALFA compared to SPY may be partially attributed to the fact that ALFA’s portfolio is quite concentrated, with the top 10 holdings accounting for 31.85% of assets, compared to only 173.03% for SPY. Moreover, ALFA currently holds only 73 stocks, compared to the 500 in the S&P 500. The following table shows the top 10 stocks held in ALFA and SPY. ALFA SPY Stock Ticker % Assets Stock Ticker % Assets Apple Inc. (NASDAQ: AAPL ) 7.25 Apple Inc. AAPL 3.75 Valeant Pharmaceuticals (NYSE: VRX ) 7.19 Microsoft Corporation (NASDAQ: MSFT ) 2.03 Celgene Corporation (NASDAQ: CELG ) 2.55 Exxon Mobil Corporation Common (NYSE: XOM ) 1.78 Horizon Pharma plc (NASDAQ: HZNP ) 2.53 Johnson & Johnson Common Stock (NYSE: JNJ ) 1.49 Allergan PLC (NYSE: AGN ) 2.41 Wells Fargo & Company Common St (NYSE: WFC ) 1.46 The Priceline Group Inc. (NASDAQ: PCLN ) 2.36 General Electric Company Common (NYSE: GE ) 1.41 Transdigm Group Incorporated Tr (NYSE: TDG ) 2.22 Berkshire Hathaway Inc. Class B (NYSE: BRK.B ) 1.4 Oracle Corporation Common Stock (NYSE: ORCL ) 2.05 JPMorgan Chase & Co. Common St (NYSE: JPM ) 1.37 Biogen Idec Inc. (NASDAQ: BIIB ) 1.79 Pfizer, Inc. Common Stock (NYSE: PFE ) 1.19 Skechers U.S.A., Inc. Common St (NYSE: SKX ) 1.5 AT&T Inc. (NYSE: T ) 1.15 Besides AAPL, which constitutes 7.25% and 3.75% of ALFA and SPY, respectively, the two funds do not have any top-10 holdings in common. Hedging mechanism ALFA has an interesting hedging mechanism, which when enforced shorts the S&P 500 in an amount equal to the value of the fund’s long holdings. In other words, ALFA becomes market neutral when the hedge is activated. The trigger for the activation is simple – almost too simple, at first glance – it’s when the S&P 500 falls below its 200-day simple moving average [SMA] at month’s end. Why month’s end, which seems like an arbitrary day to choose? Why not the 15th of each month, or the 19th? Surprisingly, choosing the end of each month as the trigger was more effective than the seemingly more logical “5 consecutive days below 200 SMA” rule on data from 1950 to 2014, presumably because the portfolio was hedged less in a long-term secular rising market. Which brings us to the main purpose of this post, which is to inform investors that, unless the S&P 500 gains in excess of 4.35% (from 1988.87 to 2075.41) on the last trading day of August, i.e. in one trading day’s time, ALFA’s hedging mechanism is about to be activated for the first time . Interestingly, this is not the first time that the S&P 500 has dipped below its 200 SMA since ALFA’s inception. As can be seen from the chart below, this has happened at least twice since May 2012. But now let’s take a closer look at each of those two instances. The first event took place in November 2012, around the time of the “fiscal cliff” negotiations. We can see from the above chart that the S&P 500 dipped below the 200 SMA in mid-November, but then recovered above the 200 SMA by month’s end. Hence, ALFA’s hedge was not activated. A similar phenomenon was observed in October 2014: Takeaway What does this mean for investors? If you already own ALFA, you have two basic choices (assuming that the S&P 500 does not rally 4.35% over the weekend). HOLD . You prefer to take a “passive” approach to market timing (an oxymoron, perhaps), and are comfortable with ALFA’s hedging strategy. You understand that ALFA will probably return close to flat in the month of September, plus or minus ALFA’s alpha, and then for every month after that until the S&P 500 breaks above its 200 SMA at month’s end. SELL . You have a strong conviction that the market will resume its uptrend in September and in the months beyond. You do not want to have part of your holdings invested in a market-neutral position, so you sell ALFA and replace it with SPY or another long-only instrument. You will only rotate back into ALFA when the S&P 500 breaks above its 200 SMA at month’s end. For investors who do not yet own ALFA and are considering whether or not to buy this fund, they should be aware that the ETF, if purchased in September, will be a market-neutral fund for at least that month, and then for every month after that until the S&P 500 breaks above its 200 SMA at month’s end. Disclosure: I am/we are long ALFA. (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.