Tag Archives: nysearcatmf

Plan To Survive: Be Systematic!

Surviving this environment is tough. Investors need evidence-based methods (EBM). This series will provide some tools. To survive the current investment environment, investors need systematic, evidence-based methods which will skew the odds in their favor. In this series, I will present a variety of strategy indices which my firm has created, which will provide some tools to aid in survival. In a the dog-eat-dog world of the financial markets, solid technology is essential. My firm has created a variety of strategy indices which have pounded the S&P 500, utilized structural forms of alpha creation, and reduced investors’ correlation to the stock market. This year, we will focus on strategies which have a low correlation to both stocks and to bonds. As always, our cutting-edge strategies are only available to subscribers, but I hope that some of the strategy indices presented here will provide inspiration for readers to create their own methods for dealing with an increasingly difficult investment environment. Remember, hope is for people who do not use data. Wise investors plan using evidence-based methods. Please note that even though the rules of this strategy index have been publicly-released, that like any other index, we require the execution of a licensing agreement with ZOMMA LLC for any form of commercial use whatsoever. ZOMMA Quant Warthog II Rules: I. Buy UPRO (NYSEARCA: UPRO ) with 30% of the dollar value of the portfolio. II. Buy TMF (NYSEARCA: TMF ) with 20% of the dollar value of the portfolio III. Buy EUO (NYSEARCA: EUO ) with 40% of the dollar value of the portfolio. IV. Buy UGL (NYSEARCA: UGL ) with 10% of the dollar value of the portfolio. V. Rebalance annually to maintain the 30%/20%/40%/10% dollar value split between the instruments. Here are the results of a backtest of these rules in a log scale: (click to enlarge) (click to enlarge) What is the intuition behind this market-thumping performance? UPRO is a 3X leveraged S&P 500 ETF. TMF is a 3X leveraged 20+ years government bond fund ETN. EUO is a 2X short Euro ETF, and UGL is a 2X leveraged gold ETF. In a flat to bullish environment for bonds, the often inverse nature of stock / bond correlation is well known. Hence the UPRO/TMF inclusion in the index. In addition, since the leverage in the instruments in non-recourse, the use of UPRO/TMF is far safer than the use of margin leverage. Indeed, UPRO/TMF can only go to zero. However, in a rising interest rate environment, long-dated government bonds often get slammed, but the higher interest rates lead the dollar to strengthen. A 2X short Euro ETF is synthetically long the dollar. When U.S. interest rates rise, since this makes the dollar more attractive, EUO should jump with rising real U.S. interest rates. Therefore, EUO acts as a hedge for TMF. In addition, a synthetic dollar long position can be an excellent hedge in a deflationary environment in which the U.S. dollar strengthens. The UGL allocation is for a potential hyperinflation or monetary debasement scenario in which bonds and the dollar get slammed. The 2X leveraged gold ETF has the ability to help in such a scenario. Remember, UGL can jump dramatically, but because the leverage in UGL is inherent to the instrument and non-recourse, it can only go to zero. Indeed, the leveraged nature of the instruments acts like a call option on various asset classes, without the margin leverage inherent in other paradigms such as Risk Parity. This strategy index is truly impressive. It has 6 percentage points less maximum drawdown than the SPY (NYSEARCA: SPY ), while having 6 percentage points more of CAGR. In addition, it accomplishes this feat with only a 0.36 correlation to SPY. Very impressive. But what is this strategy index’s correlation to long-dated government bonds? Here are the results of a backtest of these rules in a log scale: (click to enlarge) The strategy index is only 0.36 correlated to leveraged long bonds as well. Extremely impressive. And with a Sharpe ratio of 1.51, the strategy is a serious tool in the investor’s toolbox. And this strategy index achieves low correlations to stocks and to fixed income, without strong commodity correlation either. Below is a log scale graph of the strategy index’s backtested rules compared to its UGL 2X leveraged gold component: (click to enlarge) The strategy index has only a 0.29 correlation to UGL. To summarize, the index has a low correlation to stocks, to bonds, and to commodities. Therefore, for investors who wisely fear that bear markets in stocks, in bonds, or in commodities could hurt their portfolios, perhaps they should consider an index which offers the chance of a low correlation to all three asset classes. Remember, hope is for people who do not use data. Wise investors plan using evidence-based methods. Solid evidence-based technology goes a long way. At the very least, this index is a valuable tool for conceptualizing issues of correlation and diversification within an evidence-based framework. Thanks for reading. Hypothetical performance results have many inherent limitations, some of which are described below. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown; in fact, there are frequently sharp differences between hypothetical performance results and the actual results subsequently achieved by any particular trading program. One of the limitations of hypothetical performance results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk of actual trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points which can also adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical performance results and all which can adversely affect trading results. Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in SPXL, TMF, EUO, UGL 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.

Improving Basic Structural Arbitrage

Adding long dollar index exposure is highly logical. It reduces the strategy index’s correlation to bonds. And it provides multiple forms of statistical hedging. As long time readers know, the idea behind Structural Arbitrage is that profits are possible by acting as a synthetic insurance company which sells expensive insurance in the volatility market, and then synthetically reinsures that market risk with long duration government bonds. To review, here are the basic strategy index’s rules: I. Buy XIV (NASDAQ: XIV ) with 40% of the dollar value of the portfolio. II. Buy TMF (NYSEARCA: TMF ) with 60% of the dollar value of the portfolio. III. Rebalance weekly to maintain the 40%/ 60% dollar value split between the positions. XIV is the inverse short term volatility ETN. TMF is the 3X leveraged 20+ year government bond ETF. Here are the strategy’s results in a linear scale: (click to enlarge) For those of you who don’t believe that such a simple strategy index could work, I made the strategy public in an ebook back in 2013. If a relationship is robust, it can still make money even if it is widely studied. The potential problem, though, is the correlation of the strategy to bonds, as we can see in the graph below which compares the strategy to its TMF component: (click to enlarge) Even though the R squared value of a 0.61 correlation to TMF isn’t horrible, it’s not great either. And as I’ve said again and again , I believe that the strategy in its original form should be abandoned, due to the risk of a prolonged bear market in bonds. A simple improvement would be to add long dollar index exposure through an instrument such as UUP. The logic is “if then” logic. If interest rates rise, TMF will fall, but the dollar might strengthen, since the higher yield makes dollars more attractive than alternatives. What exactly would an improvement consist of? Here are the improved strategy’s rules: I. Buy XIV (NASDAQ:) with 15% of the dollar value of the portfolio. II. Buy TMF (NYSEARCA:) with 15% of the dollar value of the portfolio. III. Buy UUP (NYSEARCA: UUP ) with 70% of the dollar value of the portfolio. IV. Rebalance annually to maintain the 15%/ 15%/70% dollar value split between the positions. Here are the strategy’s results in a linear scale: (click to enlarge) The strategy now lags the S&P by 1.1% per year, but the drawdown is reduced by almost 8 percentage points, far improving the CAGR/Max drawdown ratio, called the MAR, compared to that of S&P 500. Let’s take a look at the correlation of the strategy to its long bond TMF component: (click to enlarge) The improved strategy index’s correlation to TMF dropped from 0.61 to 0.35. And the improved strategy index’s correlation to the S&P 500 is only 0.13 (pretty amazing) dropping from an already impressive 0.17 level. For the investor who is looking for a return stream which is largely uncorrelated to stocks and uncorrelated to bonds , this improved strategy index is pretty neat. Both long bonds and long dollar index exposure can often statistically hedge short volatility exposure. The lesson here is that multiple forms of hedging are usually better if the goal is robustness and non-correlation. Thanks for reading. Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in XIV, TMF, UUP 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.

Fire Your Investment Manager: A Refined All-Long Strategy IV

The strategy has been further improved. We use multiple markets for both return generation and hedging. This improves returns in relation to risk. The strategy can survive shocks in both the equity and the fixed income markets. Here are the refined strategy’s rules: 1. Buy SPXL (NYSEARCA: SPXL ) with 40% of the dollar value of the portfolio. 2. Buy ZIV (NASDAQ: ZIV ) with 20% of the dollar value of the portfolio. 3. Buy TMF (NYSEARCA: TMF ) with 35% of the dollar value of the portfolio. 4. Buy TVIX (NASDAQ: TVIX ) with 5% of the dollar value of the portfolio. 5. Rebalance annually to maintain the 40%/20%/35%/5% dollar value split between the positions. Here are the strategy’s results in a log scale: (click to enlarge) The strategy’s performance is outstanding. During the test period, it beats the market by over 20 percentage points per year, while enjoying a lower max drawdown. We can understand how the refined strategy accomplishes this by breaking down the strategy into its return-generating components and its hedging components . Synthetically selling Mid-Term Volatility and holding a leveraged S&P 500 position create the return-generating components of the strategy . Then, holding a leveraged Long Bond position and holding a leveraged Short-Term Volatility position create the hedging components of the strategy . The refined strategy uses multiple markets for both return generation and hedging, smoothing returns, and increasing the strategy’s robustness to shocks in both the equity and the fixed income markets. The net result is outstanding. This strategy index would be perfect for an ETF provider which wishes to launch a product which can beat the SPY even in a bull market, while also enjoying moderate correlations to both equities and fixed income. During the recent stock market confusion, the strategy has really hit its stride. The last 12 months: (click to enlarge) The last 6 months: (click to enlarge) The last 3 months: (click to enlarge) 2015 YTD: (click to enlarge) The sharpe and CAGR/Max Drawdown ratios just destroy the performance of the S&P 500. When faced with this type of technology, I cannot understand why anyone would want to invest in conventional stock picking funds or traditional asset allocation regimes such as risk parity. The strategy powers through market chop. The index is hedged multiple ways, unlike most strategies which solely rely upon bonds as the hedging component. That’s why the strategy has a low correlation to both stocks and bonds. It has volatility exposure in order to help achieve absolute returns during market dislocations. We believe that our more advanced strategies should replace most equity/bond/commodity mixes, since they are empirically safer. And after a multi-decade bond bull market, hedging using multiple markets is the responsible thing to explore.