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The Time To Hedge Is Now! December 2015 Update

Summary Overview of strategy series and why I hedge. Short summary of how the strategy has worked so far. Some new positions I want to consider. Discussion of risk involved in this hedge strategy. Back to Do Not Rely On Gold Strategy Overview If you are new to this series, you will likely find it useful to refer back to the original articles, all of which are listed with links in this instablog . It may be more difficult to follow the logic without reading Parts I, II and IV. In Part I of this series, I provided an overview of a strategy to protect an equity portfolio from heavy losses in a market crash. In Part II, I provided more explanation of how the strategy works and gave the first two candidate companies to choose from as part of a diversified basket using put option contracts. I also provided an explanation of the candidate selection process and an example of how it can help grow both capital and income over the long term. Part III provided a basic tutorial on options. Part IV explained my process for selecting options and Part V explained why I prefer to not use ETFs for hedging. Parts VI through IX primarily provide additional candidates for use in the strategy. Part X explains my rules that guide my exit strategy. All of the articles in this series include varying views that I consider to be worthy of contemplation regarding possible triggers that could lead to another sizeable market correction. I want to make it very clear that I am NOT predicting a market crash. I merely like to take some of the pain out of the downside to make it easier to stick to my investing plan: select superior companies that have sustainable advantages, consistently rising dividends and excellent long-term growth prospects. Then I like to hold onto those investments unless the fundamental reasons for which I bought them in the first place changes. Investing long term works! If you are interested in a more detailed explanation of my investment philosophy, please consider reading ” How I Created My Own Portfolio Over a Lifetime .” Why I Hedge If the market (and your portfolio) drops by 50 percent, you will need to double your assets from the new lower level just to get back to even. I prefer to avoid such pain, both financial and emotional. If the market drops by 50 percent and I only lose 20 percent (but keep collecting my dividends all the while), I only need a gain of 25 percent to get back to even. That is much easier to accomplish than doubling a portfolio and takes less time. Trust me, I have done it both ways, and losing less puts me way ahead of the crowd when the dust settles. I view insurance, like hedging, as a necessary evil to avoid significant financial setbacks. From my point of view, those who do not hedge are trying to time the market, in my humble opinion. They intend to sell when the market turns but always buy the dips. While buying the dips is a sound strategy, it does not work well when the “dip” evolves into a full-blown bear market. At that point, the eternal bull finds himself catching the proverbial rain of falling knives as his/her portfolio tanks. Then panic sets in and the typical investor sells when they should be getting ready to buy. A short summary of how the strategy has worked so far I have been hedged since April 2014. In 2014, our only significant candidate win was Terex (NYSE: TEX ) which provided gains of over 600 percent to help offset some of my cost. I missed taking some profits in October of 2014 that could have put me in the black for the year, but by doing so, I would have left my portfolio too exposed, so I let most of those positions expire worthless. It is insurance, after all. The results for 2015 have been stellar! I like it when the market gives me a gain in early December because the likelihood of a year-end (Santa Claus) rally is very high and will usually give me an opportunity to redeploy the profits before the rest of my positions expire. I could have taken more gains but decided to leave some on the table in case the rally did not materialize to keep my portfolio mostly protected. I explained all my moves in the last article of the series linked at the top. My biggest winners in 2015 were Men’s Wearhouse (NYSE: MW ) with gains of over 2,700 percent, Micron Technologies (NASDAQ: MU ) with gains of up to 1,012 percent, Sotheby’s (NYSE: BID ) with gains of up to 1,500 percent, Seagate Technologies (NASDAQ: STX ) gaining over 570 percent, and Williams-Sonoma (NYSE: WSM ) with a gain of 527 percent. The gains realized on sold positions now puts me in a position of needing to add some hedges going into 2016, but with plenty of available cash. I will only deploy enough of those gains to protect my portfolio through the end of June 2016 and hold onto the rest to be deployed into new positions to provide a hedge through January 2017. Some new positions I want to consider Do not forget that I usually buy multiple positions in each candidate that I use and you should, too, unless you get in at a particularly good premium and strike. I add positions as I find I can do better than what I already own in order to improve my overall hedge. Sometimes I may buy only half or a third of the position I intend to own in the first purchase. As we get deeper into this bull market (if it still is a bull), I try to stay closer to fully hedged as much as possible. I will be hedging most of my portfolio again over the next month or so since most of my remaining positions are set to expire in mid-January of 2016. I cannot emphasize this enough: buy put options on strong rally days! Here is the list of what I would buy next and the premiums at which I would make the purchases. I may get in if the premium gets down close to my buy price and you will need to make such decisions for yourself. This is a different format from what I have used prior to this month. I will be placing good until cancelled orders at or just below my target premiums to get the positions I want when available without my having to watch daily. I list the candidates in the order of my preference. I will explain how many contracts per $100,000 of portfolio value will be needed and list the expiration months below the table. Symbol Current Price Target Price Strike Price Ask Prem Buy At Prem Poss. % Gain Tot. Est. $ Hedge % Cost of Portfolio RCL $99.92 $22 $75 $1.85 $1.80 2,844 $5,120 0.180% GT $32.79 $8 $28 $1.25 $1.25 1,500 $3,750 0.250% ADSK $61.85 $24 $50 $2.03 $1.80 1,344 $4,840 0.360% SIX $54.63 $20 $45 $1.30 $1.20 1,983 $4,760 0.240% LB $96.82 $30 $85 $2.65 $2.50 2,100 $5,250 0.250% LVLT $54.40 $20 $48 $2.20 $1.90 1,374 $2,610 0.190% TPX $71.64 $20 $60 $2.85 $2.50 1,500 $3,750 0.250% UAL $59.78 $18 $50 $2.29 $2.00 1,500 $3,000 0.200% MAS $28.44 $10 $25 $1.25 $0.85 1,665 $4,245 0.255% ETFC $29.71 $7 $27 $1.87 $1.25 1,500 $3,750 0.250% I will need only one June 2016 RCL put option contract to provide the coverage indicated in the above table. Remember that this is one of eight positions, each designed to hedge one-eighth of a $100,000 portfolio against a 30 percent drop in the S&P 500 Index. I will need eight positions from the table above to protect each $100,000 of equity portfolio value. To protect a $500,000 portfolio, I would need to multiply the number of contracts in each of my five positions by five to be fully protected. Below is a list of the expiration month (all expire in 2016) and number contracts needed for each position I use. Royal Caribbean Cruises Ltd. (NYSE: RCL ) June One Goodyear Tire (NASDAQ: GT ) July Two Autodesk (NASDAQ: ADSK ) July Two Six Flags (NYSE: SIX ) June Two L Brands (NYSE: LB ) May One Level 3 Communications (NYSE: LVLT ) June One Tempur Sealy (NYSE: TPX ) June One United Continental (NYSE: UAL ) June One Masco (NYSE: MAS ) July Three E – Trade Financial (NASDAQ: ETFC ) June Two If I use only the first eight positions listed above, I would protect each $100,000 of equity portfolio value against a drop of approximately $33,080 for a cost of $1,920 (plus commissions). What this means is that if the market falls by 30 percent, my hedge positions should more than offset the losses to my portfolio. This coverage only provides about six months of additional protection, but I have more than double that from my gains taken this year. Hopefully, there will more gains available to further offset future losses come summer and I will roll my positions again (and again, if necessary) until we finally have a recession. Both MAS and ETFC “Buy at Premiums” listed above are below the range of the current bid and ask premiums. That was the case with all of the premiums I used in the last article and most of those have been achieved already. Patience often pays off in lower costs. All of the other premiums listed are within the current range and should be available either immediately or with a small additional rally. I do not intend to chase these premiums and will try to get lower premiums when available. I expect that the current rally could extend into year-end giving me a better entry point on some of these candidates and possibly some others that just do not work at this level. I will provide another update if that opportunity occurs. But I am not ready to take that possibility to the bank, so I will place some orders Monday morning. I do not try to hedge the bond portion of my portfolio with equity options. For those who would like to hedge against a rout in high-yield bonds, I use options on JNK and may add HYG as a candidate for that purpose. If that seems interesting, please consider my recent article on the subject. Discussion of risk involved in this hedge strategy If an investor decides to employ this hedge strategy, each individual needs to do some additional due diligence to identify which candidates they wish to use and which contracts are best suited for their respective risk tolerance. I do not always choose the option contract with the highest possible gain or the lowest cost. I should also point out that in many cases I will own several different contracts with different strikes on one company. I do so because as the strike rises, the hedge kicks in sooner, but I buy a mix to keep the overall cost down. To accomplish this, I generally add new positions at the new strikes over time, especially when the stock is near its recent high. My goal is to commit approximately two percent (but up to three percent, if necessary) of my portfolio value to this hedge per year. If we need to roll positions before expiration there may be additional costs involved, so I try to hold down costs for each round that is necessary. My expectation is that this represents the last time we should need to roll positions before we see the benefit of this strategy work more fully. We have been fortunate enough this past year to have ample gains to cover our hedge costs for the next year. The previous year, we were able to reduce the cost to below one percent due to gains taken. Thus, over the full 20 months since I began writing this series, our total cost to hedge has turned out to be less than one percent. I want to discuss risk for a moment now. Obviously, if the market continues higher beyond January 2016, all of our old January expiration option contracts that we have open could expire worthless. I have never found insurance offered for free. We could lose all of our initial premiums paid plus commissions, except for those gains we have already collected. If I expected that to happen, I would not be using the strategy myself. But it is one of the potential outcomes and readers should be aware of it. I have already begun to initiate another round of put options for expiration beyond January 2016, using up to two percent of my portfolio (fully offset this year by realized gains) to hedge for another year. The longer the bulls maintain control of the market the more the insurance is likely to cost me. But I will not be worrying about the next crash. Peace of mind has a cost. I just like to keep it as low as possible. Because of the uncertainty in terms of how much longer this bull market can be sustained and the potential risk versus reward potential of hedging versus not hedging, it is my preference to risk a small percentage of my principal (perhaps as much as two percent per year) to insure against losing a much larger portion of my capital (30 to 50 percent). But this is a decision that each investor needs to make for themselves. I do not commit more than three percent of my portfolio value to an initial hedge strategy position and have never committed more than ten percent to such a strategy in total before a major market downturn has occurred. The ten percent rule may come into play when a bull market continues much longer than expected (like five years instead of 18 months). And when the bull continues for longer than is supported by the fundamentals, the bear that follows is usually deeper than it otherwise would have been. In other words, at this point, I would expect the next bear market to be more like the last two, especially if the market continues higher through all of 2016. Anything is possible but if I am right, protecting a portfolio becomes ever more important as the bull market continues. As always, I welcome comments and will try to address any concerns or questions either in the comments section or in a future article as soon as I can. The great thing about Seeking Alpha is that we can agree to disagree and, through respectful discussion, learn from each other’s experience and knowledge.

Hedge After Reading

Summary A JP Morgan study found that 40% of stocks since 1980 have suffered “catastrophic losses”, meaning declines of 70% or more without recovering. Although JP Morgan calls for diversification in response, the statistic suggests diversification’s ability to ameliorate stock-specific risk is limited: what if 40% of your stocks suffer catastrophic losses? Hedging can prevent catastrophic losses, but its cost raises questions about when it makes sense to hedge. We offer two rules to clarify the tradeoffs and a sample hedged portfolio. Why Consider Hedging Why consider hedging securities at all? Why not just weather declines and wait for prices to recover? One answer is that often security prices never recover. According to a JP Morgan (NYSE: JPM ) report shared by Wall Street Journal reporter Morgan Housel (“Falling from grace: catastrophic losses in Russell 3000 prices”), since 1980, 40% of stocks have suffered permanent, catastrophic losses, meaning they fell at least 70%, and never recovered (Morgan Housel is pictured below; the illustration is from his Twitter (NYSE: TWTR ) profile page ). As the pull-quote below, taken from the JP Morgan report, notes, catastrophic losses aren’t confined to recessions; they happen all the time. The report goes on to note that different sectors suffer higher percentages of catastrophic losses at different times. For example, the oil price collapse of the early 1980s led to more than 40% of energy companies suffering catastrophic declines during that period, as the graph below from the report shows. Bear in mind that the graph above goes to the end of 2014. If the recent rout in oil continues, it’s possible we’ll see another spike in catastrophic loss rates for energy companies going forward. Hedging, Diversifying, or Holding Cash Given how common catastrophic losses in stocks have been, the first answer that may come to mind when considering when it makes sense to hedge is, “when you want to avoid catastrophic losses”, but that’s a bit too facile. After all, you can limit such losses without hedging: for example, by holding high levels of cash. Another way often mentioned to limit stock-specific risk without hedging individual holdings is to diversify; in fact, the JP Morgan report itself suggests this in the pull-quote below. If you’re confident that diversification can sufficiently limit your stock-specific risk, then you could simply diversify, and focus your risk management on ways to limit your market risk, which diversifiction doesn’t ameliorate. We discussed ways to do that in a previous article, How To Limit Your Market Risk . But, after having read the JP Morgan paper, we’re left with this question: what happens if you’re diversified and 40% of your stocks suffer catastrophic losses? It would seem that diversification alone might not protect your portfolio against a decline you would find unacceptable. So, we’re back to considering hedging individual positions, or holding cash. Holding Cash as an Alternative to Hedging Holding cash has the advantages of being simple, and cost-free (not counting opportunity cost). If, for example, the maximum drawdown you’re willing to risk is 10%, and you have 90% of your money in cash, then if everything you own with the other 10% suffers catastrophic losses, in the worst case scenario, your portfolio won’t be down more than 10%. Seeking Alpha contributor William Koldus, CFA, CAIA suggested a 90% cash portfolio in a recent article (“Why A 90% Cash Portfolio Will Likely Outperform”), but investors seeking higher returns may not want to hold such a high cash position. For those investors, a portfolio where each position is hedged may be preferable, so we’ll look at a couple of rules to guide their hedging and security selection decisions in constructing such a portfolio. Then, we’ll offer a sample hedged portfolio. These rules may seem obvious in hindsight, but could prove to be useful additions to your ” latticework of mental models “. Rule #1: Count The Cost Of Hedging Recall the example we mentioned above of an investor unwilling to risk a drawdown of more than 10%. We’ll refer to that 10% as his decline “threshold”. Let’s say that investor was using put options to hedge. Put options, for those who may benefit from a refresher, are contracts that give an investor the right to sell a security for a specified price (the strike price) before a specified date (the expiration date), regardless of where the market price of the security is at that time. For example, if you have a put option with a strike price of $10, and the price of your underlying stock drops to less than $5, you can still sell your stock for $10 per share.* Given the time frame over which he was looking to hedge, our hypothetical investor would want to find the put options that would protect him against a greater-than-10% decline at the lowest cost. When doing so, he’d need to take into account the cost of the hedge as it applies to his threshold: for example, let’s say there was a put option with a strike price 10% below the current market price of his stock, but it would cost 5% of his position value to buy it. If he bought that bought option, he’d actually be risking a 15% drawdown, taking into account the cost of the hedge. If the investor were using Portfolio Armor’s hedging app to find the optimal puts for a 10% threshold, the app would do this automatically, so, in the worst case scenario, the market value of the investor’s underlying stock, plus its hedge (minus the initial cost of the hedge) would total no less than 90% of the starting market value of his underlying stock position. The cost of hedging can also be used as a way to screen out some potentially bad investments, as we elaborated on in a recent article, 2 Screens To Avoid Bad Investments . Rule #2: Potential Return Must Exceed Hedging Cost Potential return here refers to an estimate of how well the security will perform over the time frame of the hedge. Let’s say that time frame is 6 months, and your threshold remains 10%, that is, you are unwilling to risk a drawdown of more than 10% over 6 months. And let’s you found a hedge that will limit the decline in your underling security to no more than 6%, and the hedge costs 4%, so it fulfills Rule #1 (you won’t be down more than your threshold, 10%, in a worst case scenario). So far, so good. But what if you estimate your underlying security has a potential return of 2% over the next six months? Then this hedged position fails Rule #2, because the potential return is less than the hedging cost: you’re potential return, net of hedging cost (your net potential return) in this case would be -2%. At a minimum, you would want your net potential return to be positive, but, ideally, you’d want to assemble a portfolio of hedged positions where the net potential returns are as high as possible, given your threshold (all else equal, the larger your threshold, i.e., the larger the drawdown you are willing to risk, the cheaper it will be to hedge, and the cheaper it is to hedge, the higher your net potential returns will be). Putting It All Together To implement this approach, for every security in your universe, you’d want to calculate the cost of hedging it against your decline threshold, eliminating all that are too expensive to hedge in that manner. Then you’d want to estimate potential returns for all of the securities that weren’t too expensive to hedge, and subtract the hedging costs from your potential return estimates, to get net potential returns. Then, you’d rank the securities by net potential return, and buy and hedge round lots (numbers of shares divisible by 100) of a handful of the ones with the highest net potential returns. That’s essentially what Portfolio Armor’s hedged portfolio construction tool does, though it adds an additional fine-tuning step. After rounding down dollar amounts to allocate to round lots of a handful of securities with the highest net potential returns in its universe (which consists of every optionable stock and exchange traded product in the US), it searches for what we call a “cash substitute”: that’s a security collared with a tight cap (1% or the current yield on a leading money market fund, whichever is higher) in an attempt to capture a better-than-cash return while keeping the investor’s downside limited according to his specifications. You could use a similar approach, or you could simply allocate left over cash to one of the securities you selected in the previous step. A Sample Hedged Portfolio Below is a hedged portfolio designed for an investor with $500,000 to invest who is unwilling to risk a drawdown of more than 10% over the next 6 months. This hedged portfolio was generated by Portfolio Armor using data as of Monday’s close. Why Those Particular Securities? After it applied its “2 screens to avoid bad investments” to its universe, eliminating inauspicious ones, the site sorted the remaining securities by potential return, net of hedging costs, or net potential return. It included Amazon (NASDAQ: AMZN ), Activision Blizzard (NASDAQ: ATVI ), Ctrip (NASDAQ: CTRP ), NVIDIA (NASDAQ: NVDA ), and Public Storage (NYSE: PSA ), because those had the highest net potential returns when hedged against > 10% declines. In its fine-tuning step, it added Regeneron Pharmaceuticals (NASDAQ: REGN ) as a cash substitute, because it had one of the highest net potential returns when hedged as one. Let’s turn our attention now to the portfolio level summary. Worst-Case Scenario The “Max Drawdown” column in the portfolio level summary shows the worst-case scenario for this hedged portfolio. If every underlying security in it went to zero before the hedges expired, the portfolio would decline 8.6%. Per Rule #1, that 8.6% maximum drawdown is inclusive of the 3.1% hedging cost, i.e., the portfolio value would only be down 5.5% not including the hedging cost, in a worst case scenario. Best-Case Scenario At the portfolio level, the net potential return is 12.74%. This represents the best-case scenario if each underlying security in the portfolio meets or exceeds its potential return. A More Likely Scenario The portfolio level expected return of 4.6% represents a more conservative estimate, based on the historical relationship between our calculated potential returns and actual returns. Each Security Is Hedged Note that in the portfolio above, each underlying security is hedged. Public Storage is hedged with an optimal put; Regeneron is hedged as a cash substitute, with an optimal collar with its cap set at 1%; and the rest of the securities are hedged with optimal collars with their caps set at their potential returns. Here’s a closer look at the hedge for Public Storage: As you can see in the screen capture above (image via the Portfolio Armor iOS app ), the cost of the PSA hedge was $2,280, or 4.55% of position value. To be conservative, the cost here was calculated using the ask price of the puts. In practice, an investor can often buy puts for less (at some price between the bid and ask), so the actual cost to purchase these puts would likely have been less. The cost of the other hedges in the portfolio was calculated in a similarly conservative manner. —————————————————————————– *Using a put option to sell an underlying security at the strike price is called “exercising” the option. In practice, you can often get the same level of protection, or better, by selling your underling security and your put option at their respective market prices than by exercising your put option. Depending on how far out the expiration date of your put option is (how much “time value” it has, in options terminology), the put option will trade for at least its “intrinsic value”, which is the difference between the option’s strike price ($10, in our example above) and the market price of the stock ($5, in the same example). So the option will trade for at least $5 in this scenario. But it may trade for more, if options market participants believe the underlying security may drop further (increasing the intrinsic value of the option) before the option expires.

ALFA Underwhelms As Hedge Fund Darlings Crater Plus An Untimely Hedge

Summary ALFA’s hedge was triggered for the first time at the start of last September. Unfortunately, ALFA’s recent performance has been uninspiring. This analysis reveals two likely reasons for ALFA’s underperformance since the hedge was activated. In my Aug. 31, 2015 article entitled ” ALFA: A Market-Beating ETF About To Go Market-Neutral ” I reported that the AlphaClone Alternative Alpha ETF (NYSEARCA: ALFA ) was about to go market-neutral for the first time since its inception due to the S&P 500 closing below its 200-day moving average at month-end. I also commented on the fact that ALFA has had significant wire-to-wire outperformance vis-a-vis the SPDR S&P 500 Trust ETF ( SPY) since inception (see chart below), suggesting that investors in ALFA benefited from being able to “invest with the best.” Recall that ALFA uses a proprietary “Clone Score” methodology in order to aggregate the ideas of hedge funds which have strong historical performance. Alas, ALFA can no longer lay claim to this achievement. Its total return performance since inception now trails SPY by some 15% (55% vs. 70%). ALFA Total Return Price data by YCharts Zooming up to the time frame since the hedge was triggered at the start of September (it was actually activated at the market close on Sep. 2nd) reveals that most of the relative underperformance occurred over the last month. ALFA Total Return Price data by YCharts Reconstructing ALFA’s return without the hedge Recall that when the hedge is triggered (caused by the S&P 500 closing below its 200-day moving average at month-end), ALFA shorts the S&P 500 in an amount equal to the notional value of its long holdings. In other words, ALFA becomes market-neutral. Obviously, given that SPY has (as of last week) reclaimed its 200-day moving average in a brief span of two months, the hedge appears to be ill-timed. Nevertheless, investors in ALFA must be prepared to accept the fact that this hedging strategy will likely underperform in whipsaw situations, such as what was observed over the past two months, as part of the cost of protecting oneself from the worst of bear markets. I wanted to see whether the severe underperformance of ALFA was due to the hedge being triggered, or something else. Therefore, I reconstructed the total return of ALFA since the start of September to visualize what the return profile of ALFA would have been if the hedge had not been activated. We can see from the chart above that had the hedge not been activated, the hypothetical 100% long ALFA (denoted ALFA-L in the graph above) would have returned -1.95% since Sep. 1st, compared to -8.14% for the actual ALFA. While this alleviates the underperformance a bit, it is still far below that of SPY at 8.69%. So what can the rest of ALFA’s underperformance be attributed to? Hedge fund darlings crater In my previous article, I compared the top 10 holdings of 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 How have the top 10 stocks of ALFA fared over the past two months? Answer: not pretty. AAPL Total Return Price data by YCharts As can be seen from the graph above, only 2 of ALFA’s top 10 holdings at the start of September, PCLN (+12.44%) and AAPL (+10.55%), have outperformed SPY. There are three massive losers: SKX (-30.5%), HZNP (-41.2%) and VRX (-48.2%). Assuming that the weightings of those three stocks did not change over this time period, they would have contributed a total of -6.24% to the total return of ALFA over this time period. That actually accounts for over half the entire difference between the hypothetical unhedged ALFA-L (-1.95%) and SPY (8.69%) during this time! Now, I am aware that ALFA’s holdings are not static, and hence the above calculation is merely an estimate. Nevertheless, it is clear that ALFA has been hit by a “doubly-whammy” of an untimely hedge, plus the underperformance of hedge fund darlings such as Valeant Pharmaceuticals (see this comically-timed Forbes article ” Hedge Fund Superstars Stocking Up On Valeant Pharmaceuticals ” that was published the day before VRX’s price came crashing down). This illustrates an important fact: even the best and brightest in the industry can sometimes get it (very) wrong. Due to ALFA’s heavy concentration in tech and biotech, one might say that SPY is not an appropriate benchmark for ALFA. The following chart therefore also shows the total return of the PowerShares QQQ Trust ETF (NASDAQ: QQQ ) and the iShares Nasdaq Biotechnology ETF (NASDAQ: IBB ) since the start of September, as well that of another hedge fund-following ETF, the Global X Guru Index ETF (NYSEARCA: GURU ). Unfortunately, ALFA still lags the other four ETFs, although the hypothetical ALFA-L (-1.95%) would have outperformed IBB (-5.12%) and closely trail GURU (-0.37%). ALFA Total Return Price data by YCharts Summary The last two months has not been kind to ALFA holders. Not only was the timing of the hedge unfortunate, but a number of the fund’s largest holdings have suffered tremendously, particularly VRX and HZNP, whose pricing practices have come under intense scrutiny. Will ALFA rebound in the future? I don’t know. As of today, VRX and HZNP are still two of ALFA’s top 10 holdings, at 3.30% and 2.00% weights, respectively, suggesting that ALFA’s future performance may still be somewhat tethered to the fates of those two specialty pharmaceutical companies. Moreover, note that while ALFA is currently in market-neutral mode, this will change if the S&P 500 manages to remain above its 200-day moving average for one more week, as the end of the month is near.