PowerShares' launched a fund last week that offers an alternate
take on off-the-shelf risk reduction, but how new is it?
The new fund, the PowerShares S&P 500 Downside Hedged
Portfolio (NYSEArca:PHDG), aims at a particular type of risk
reduction; namely, limiting the impact of major market downturns on
This conjures up images of some kind of missile defense against
PHDG uses a derivative overlay to meet this ambitious goal. It
dynamically allocates to futures on the CBOE Volatility index, aka
the VIX. (I don't mean to gloss over the word "futures," and I'll
circle back to this later.) PHDG can even go to all cash when the
you know what
hits the fan.
This method of risk reduction stands in stark contrast to that
of its hugely popular sister fund, the PowerShares S&P 500 Low
Volatility ETF (NYSEArca:SPLV). SPLV and similar funds, such as the
iShares MSCI USA Minimum Volatility Index Fund (NYSEArca:USMV) rely
on stock selection to reduce risk, seeking out names with low
) or low correlation (
The new fund, PHDG, meanwhile aims to match the returns of the
S&P 500 Dynamic Veqtor Index. PHDG faces well-established
competition in this respect:the Barclays S&P Veqtor ETN
(NYSEArca:VQT) tracks the very same index.
PHDG offers an immediate advantage over VQT:a lower fee. PHDG
costs 39 basis points versus VQT's 95 basis points. PHDG's ETF
structure also eliminates the counterparty risk that's baked into
all ETNs:VQT is backed solely by the credit of its issuer, Barclays
Still, VQT brings real heft to the fight. It boasts assets of
about $350 million and decent liquidity-7 basis points in bid/ask
spreads on $2 million in average daily trading volume. The
tradability in particular must be factored in when measuring all-in
Brand-new funds like PHDG often trade at wide spreads, which
means the two products' all-in costs are closer than the headline
fee difference implies.
VQT has another edge:tracking. As an ETN, it essentially
delivers the returns of its index perfectly, less its admittedly
huge fee. PHDG has the normal tracking disadvantages of an ETF,
plus one more:It's actively managed.
The fund clearly aims to match the index's returns, not beat
them, so its "active" designation is a bit odd until one considers
the recent SEC ruling allowing derivatives in new active funds
Perhaps the timing is coincidental, but the bottom line is that
PHDG will show more tracking volatility than VQT, even if it tries
to have it both ways by claiming zero tracking error as an active
Enough with the esoterica. Does this black-swan killer really
work? And if so, what's the cost in upside?
Obviously we don't have performance data on shiny new PHDG, but
the index underlying both PHDG and VQT-the S&P 500 Dynamic
Veqtor Index-makes a great reference to examine. I chose VQT's
inception date of Aug. 21, 2010 as a starting point, and the chart
ends at Dec. 6, 2012.
This period includes a black swan of sorts in the form of
Standard & Poor's ignominious downgrade of U.S. debt in August
2011, an event marked by the sharp drop of the S&P 500 index,
shown here in dark blue.
The first point here is that VIX futures track the VIX poorly
over time, and generally lead nowhere but down in the long run. The
S&P 500 Dynamic Veqtor Index has exposure to VIX futures, not
to the VIX itself, which is uninvestable.
The saving grace is the "dynamic" in the S&P 500 Dynamic
Veqtor Index-it does not maintain a large fixed weight in VIX
futures. Still, anyone consider either PHDG or VQT needs to have
some inkling of how VIX futures perform.
In the end, I'm guessing that PHDG will offer some protection
against major market upsets, just as VQT has done to-date.
As for PHDG versus VQT, I'd look hard at the spreads and your
intended holding period before deciding if PHDG's lower fee really
pays off, and don't forget the age-old counterparty risk versus
tracking issue for VQT.
If I had to invest in one of them soon, I'd stick with VQT until
fledgling PHDG gets some traction.
At the time this article was written, the author had no
positions in the securities mentioned. Contact Paul Britt at
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