Tag Archives: etf-long-short-ideas

What Can Russia Offer To Your Portfolio?

Summary RSX is down over 50% since the beginning of 2011, suggesting attractive expected returns. Russian equities offer diversification benefit to U.S. investors. However, high volatility of such an investment means that the actual portfolio risk contribution will be 2.5-3 times higher than its portfolio weight. I was recently browsing Research Affiliates Asset Allocation website and one chart that drew my attention was the forecast real 10-year expected return. As can be seen from the histogram below, projected returns by Research Affiliates models for various countries and regions differ widely with Russia comfortably offering the highest expected reward: (click to enlarge) This prompted me to explore how a modest allocation to Russian equities affects a typical portfolio held by a U.S. investor. For the purpose of this article, I use the 60/40 portfolio as a proxy for a “standard” allocation (even though I still think it is flawed ), with the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) representing equities and the Vanguard Total Bond Market ETF (NYSEARCA: BND ) – fixed income. While ETFdb lists 6 Russian equity ETFs available in the U.S., the Market Vectors Russia ETF (NYSEARCA: RSX ) is the obvious choice given that its $2 billion of assets under management is almost 4 times more than the remaining funds have combined. Portfolio impact To start with, assume that we allocate 5% of the equities portion in the 60/40 portfolio to RSX. Analyzing 5 years of historical data, risk parameters of such a portfolio look as follows: (click to enlarge) Source: InvestSpy Retrospectively, such an investment would have been a real drag in a portfolio that otherwise had a stellar performance. RSX has lost 45% of its value over the last 5 years and experienced a whopping 65% drawdown. Furthermore, its annualized volatility stood at 34%, which was more than twice that of SPY. This lead to a significant risk contribution of 14% to the overall portfolio risk despite the allocation of only 5%. On the bright side, further inspection of the correlation matrix suggests that RSX has the potential to offer diversification benefits. Its correlations were 0.67 with SPY and negative 0.21 with BND (see the table below). In fact, the correlation coefficient with SPY was even lower at 0.47 over the last 12 months. Source: InvestSpy As demonstrated in this whitepaper by Salient Partners, a diversifier with high volatility is among the most powerful tools an investors has. And RSX definitely ticks the high volatility box. At the same time, it is highly unlikely that a U.S. investor would want to have 10%+ of their portfolio risk come from Russia. An investment in any Russian ETF will have 2.5-3 times higher risk contribution than its portfolio weight, thus I would not suggest a higher allocation than 2-3% of your portfolio to RSX or a related fund. One also has to bear in mind that Russian stocks will typically be included in most emerging markets ETFs and mutual funds, thus you may already have some exposure to this country. Under the hood Comparing the sector breakdown of RSX and SPY, it becomes apparent that Russian and American markets have completely different composition: RSX is largely dominated by the energy sector (43%), whilst oil & gas stocks account for only 7% of S&P 500. RSX is also heavily loaded with Materials (19%) but lacks more significant presence of companies operating in IT, health care, consumer discretionary or industrials sectors. Given that Russian stock market is so dependent on the energy sector, I have also checked how correlated to the oil price it is. Using t he United States Oil ETF, LP (NYSEARCA: USO ) as a proxy for the oil market, it turns out that over the last 5 years RSX had correlation with USO of 0.53. Although this reading does not seem exceptionally high at a first glance, I have previously shown that a coefficient above 0.5 comfortably puts RSX among top 5 single country ETFs to benefit from oil price recovery. Conclusion Russian stocks have been in a downward spiral since 2011, currently offering attractive valuations compared with other countries. RSX regained 10% in the last month and is a primary target to benefit from a potential reversal in the oil market. If the actual performance of Russian equities comes anywhere close to the returns forecast by Research Affiliates, RSX may very well be a welcome addition to your portfolio.

A High-Yield Option For Income Investors

Investing in financial markets has become considerably more difficult since the summer. High yielding assets, as well as stocks have taken a beating. Market Vectors High-Yield Muni ETF, however, has seen a steady increase in principal, while providing an attractive dividend yield. As the Treasury yield curve has contracted, alongside falling equity markets, investors have been left with few avenues to invest. Higher yielding dividend stocks, generally yielding below 3%, have seen declines in principle due to the most recent equity market rout. Additionally, junk bonds have seen broad selling pressure as investors shunned riskier assets for fear of slowing economic activity. A lone star, however, has emerged in the form of the Market Vec tors High-Yield Municipal Index ETF (NYSEARCA: HYD ) . This asset has risen close to 4% since early July, while yielding a dividend of 4.81%. This combination of appreciation of principle, as well as stable dividend yield, could be a smart play for investors seeking income in coming months. With the Federal Reserve stuck to its zero-bound lending rate, income investors have had trouble finding sustainable income sources. The global economy continues to weaken, alongside the persistence of foreign central banks loosening monetary policy, causing the Fed to potentially have trouble hiking rates in the near future. The chart below is of the iShares 7-10 Year Treasury Bond ETF (NYSEARCA: IEF ) over the iShares 20+ Year Treasury Bond ETF (NYSEARCA: TLT ) . This indicator represents the Treasury yield curve. When the indicator declines, it signals a contraction of the yield curve, and thus lowered expectations of a rate hike for monetary policy. Since peaking in the summer of 2015, slowing economic growth, and global financial market volatility has spooked Fed members, forcing them to push out their projected time frame for hiking rates. Furthermore, with investors continuing to buy bonds, yields have fallen to levels providing very little income for investors. (click to enlarge) Moreover, financial market volatility has pushed both junk bonds, and broader equity markets lower. Investors feel that equity markets have topped globally, and the combination of falling currencies, and commodities signal that global growth concerns are finally resulting in increased caution. While dividend stocks may be outperforming the market on a relative basis, these companies are still losing value in 2015. As U.S. earnings season disappoints, investors are pushing all sectors lower. Additionally, weak equity market performance is weighing on junk bonds as risk sentiment diminishes. After my degradation of basically every asset class, there seems to be one lone performer that has provided true safe-haven status. High yielding municipal bonds have outperformed as investors favor the comfort of government backed securities, alongside an attractive yield. As municipalities have lowered their leverage in recent years, their perceived stability has risen. This index also does a nice job of spreading risk, allowing investors to get exposure to a basket of riskier municipal bonds, with lower overall default risk. The Market Vectors High-Yield Muni ETF has proven a strong investment amid the recent volatility in bonds, equities, and currencies. As long as the Fed prolongs raising rates, and financial markets remain volatile, this high yielding municipal ETF should provide steady gains. (click to enlarge)

Exiting A Short VIX Trade

Summary A common question I receive, answered here. An update on the contango and backwardation strategy. Current advice on the VIX. Hello everyone, I hope you have had a profitable month so far. A common question I receive revolves around when to exit a short VIX trade. There really isn’t a common answer to this question but I would be happy to share what I do. Before we begin our discussion I wanted to go over a few things. I believe volatility trading can be done by all different types of investors. I personally follow a very simple method and I know there are many others here that comment with more complex strategies. In reality they all follow the very basic principles of buy low and sell high or in the case of shorting volatility short high cover low. Once you have a good understanding of the basics in volatility, I encourage you to keep increasing your knowledge by reading higher level articles and studies to further your understanding of volatility products. Many times the final piece to understanding lies in the why. Once you can accurately explain why, then you have reached mastery. I have always focused more on the how to than the why. Next summer, I am making a goal to change that and will begin focusing more on the why then the how to. I have spent a great deal of time putting together educational pieces on volatility products and you can view all of those in my Seeking Alpha library. My articles have focused on the basic principles of volatility trading. I started writing to help beginner to moderate level traders who are interested in trading volatility products. When I started trading volatility, not many resources existed for the average investor. I will continuously link back to those pieces and try to promote investor education throughout this transition. One last thing, the comment sections of my articles are always my personal favorite. Even though I don’t respond to every comment, I do read them all and am continuously impressed by what I read. Some of you write such good comments that you should look into actually writing an article or two for Seeking Alpha. Just think about it. I think you would make great contributors. Exiting the short VIX trade A reader suggested strategy for entering a short position in the VIX is posted under this article on contango and backwardation . That article looks into the entry points for shorting the VIX. However, it leaves the exit point up in the air and only causes an exit trade once futures re-enter backwardation from contango. That really isn’t the best overall exit strategy. For the basis of today’s discussion we will use the iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA: VXX ). Another favorite short of mine is the Proshares Ultra VIX Short-Term Futures (NYSEARCA: UVXY ). VXX invests in front and second month futures contracts. For more on how this ETN operates, click here . If you wait until futures have re-entered backwardation to exit your short position in VXX then you lose some of the profit you could have locked in at a previous date. During the bull market, we have seen extremely long periods of contango which drags VXX down over time. If you are short these shares directly then you may be racking up holding costs by not exiting after a certain period of time. If you are short VXX using options, then you might not have the same concerns. See below for an updated table of the contango and backwardation strategy for VXX. Start dare (enters contango) End date (enters backwardation) Percent Change in VXX 5/21/2012 12/28/2012 -51.56% 12/31/2013 2/25/2013 -16.43% 2/26/2013 6/20/2013 -12.50% 6/21/2013 10/07/2013 -24.72% 10/10/2013 10/15/2013 2.9% 10/16/2013 12/16/2013 -12.02% 12/18/2013 1/30/2014 6.45% 2/7/2014 3/14/2014 5.52% 3/17/2014 4/11/2014 -0.44% 4/14/2014 10/9/2014 -27.37% 10/21/2014 10/22/2014 6.79% 10/23/2014 10/27/2014 2.15% 10/28/2014 12/12/2014 11.08% 12/17/2014 1/6/2014 10.1% 1/8/2015 1/12/2015 9.48% 1/21/2015 1/28/2015 7.6% 2/3/2015 7/8/2015 -35.58% 7/10/2015 8/20/2015 -8.7% 9/16/2015 09/17/2015 7.5% 10/08/2015 volatilityetfs.blogspot.com Table created by Nathan Buehler using historical data from the Intelligent Investor Blog . What you should notice from the above table is the very poor results from 10/21/2014 on. Overall the strategy is profitable but requires very long periods of contango to be highly successful. My exit timing After the VIX has reached a peak and volatility begins to wane, I will set a profit and time target once entering a short position. I prefer not to be in a trade longer than a month. The time frame is more of a risk management tool than about profitability. Generally I set a profit target of around 25%. Now my 25% profit target will not follow the above table because it is a mixture of options and inverse volatility products such as the VelocityShares Daily Inverse VIX Short-Term ETN (NASDAQ: XIV ). To be clear on the time target, I am a worrier. You have to remember I am in a classroom all day and can’t really track what is happening in real time. The shorter I can make my profit target and get out, the happier I am. Waiting for backwardation to reappear can have two side effects. First, you are losing out on your full profit potential. Second, you are trading too often and instead of creating opportunities you are sometimes manufacturing loses. Current Advice Many investors initiated short volatility trades during the past few weeks. I encourage you to follow the above recommendations on exiting the position. Set a profit target and then close out the trade. A focus on U.S. economics should remain as any weakness will send the VIX surging again. So far, especially with jobs data, things continue to look positive. Seasonally volatility will wane after October and into the holiday season. All eyes are going to be on The Fed until liftoff. In case of a trend reversal be ready to lock in profits here. I have a small position in XIV and it has done better than I expected it to. Don’t force any trades here and never chase volatility on a fear of missing out. If you missed this one, wait it out for the next round. I highly appreciate you reading, as always!