Although the ETF industry has experienced some growing pains in
recent weeks thanks to a number of closures, the space is still
undoubtedly expanding. This is best evidenced by continued inflows
into the ETF space and a host of new fund launches in a number of
key market sectors.
This trend continues here in September as the Royal Bank of
Scotland has released its latest trend-following ETN, the
US Large Cap Alternator Index Note (
. The product looks to charge investors 1.0% per year in fees and
hopes to give investors a new way to play the large cap market in
In essence, the product will track the RBS US Large Cap
Alternator index, which utilizes a relative strength strategy in
order to decide which of the following three components to allocate
assets to; the S&P 500 Index, the S&P 500 Low Volatility
Total Return Index, or the S&P 500 Equal Weight Index (see
3 ETFs to Prepare for the Fiscal Cliff
In this way, ALTL will always be allocated to a type of the
S&P 500 benchmark, although it will have some flexibility in
terms of its focus depending on which way the market is trending
and which allocation methodology is outperforming.
The note looks to dynamically allocate between the
aforementioned three indexes based on observed price trends at the
end of every calendar month. The product will take the simple
average of the returns for the underlying indexes for the prior
one, three, six, nine, and 12 month periods, allocating the full
note towards the index with the highest average using these metrics
Alternative ETF Weighting Methodologies 101
Seemingly, this strategy will focus in on the low volatility
version when broad markets are slumping, while the more small
cap-centric equal weight index will probably be the note's mainstay
during surging market environments. Meanwhile, the 'regular'
S&P 500 index will likely be the default when no true
leadership is seen in the broad market.
Investors should also note the product structure of ALTL and
that it is an ETN as opposed to an ETF. This means that the product
is an unsubordinated debt security of RBS, and instead of holding
the securities in the indexes, will nominally cycle between the
benchmarks, pretty much eliminating tracking error and trading
costs in the process (see
ETFs vs. ETNs: What's The Difference?
ALTL in the RBS lineup
The new product represents a pretty novel way to invest in the
markets that could have some appeal to investors seeking a play
across business cycles. The strategy also represents the first
departure for RBS from its 'Trendpilot' strategy, which is the
basis for the company's other seven ETNs.
These products, many of which have failed to garner investor
attention, also employ simple moving averages in order to determine
which asset class to invest in. However, these notes only have one
choice; if the main asset is trending below its 200-day moving
average, go to cash (3-month T-bills).
Since ALTL looks to always be exposed to the market instead,
this marks the first time RBS has used a fully invested approach in
its ETN lineup. Given this and the possible benefits of
implementing this strategy in ETN form-lack of tracking error and
trading costs by cycling between the benchmarks-this product could
see a reasonable amount of interest from investors (see
Are The Trendpilot ETNs Better than Broad Market
Yet with that being said, RBS will likely encounter some
resistance from cost conscious investors as the product looks to
charge far more than similar trend following products or broad
market ETFs. In fact, if you add up the expense ratios for the
three ETFs that are required for this strategy,
(S&P 500 Index),
(S&P 500 Low Volatility Total Return Index), and
(S&P 500 Equal Weight Index), you get a cost that is about 25%
less than ALTL's expense ratio.
This suggests that RBS believes that there is definitely some
value-at least 25 basis points for sure-in using its ETN technique
in order to accomplish this large cap rotational strategy. Whether
investors agree with this philosophy and are willing to sacrifice a
higher expense ratio for ease of use, remains to be seen,
especially in this extremely liquid corner of the market.
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Author is long RSP
(ALTL): ETF Research Reports
GUGG-SP5 EQ ETF (RSP): ETF Research Reports
POWERSH-SP5 LVP (SPLV): ETF Research Reports
SPDR-SP 500 TR (SPY): ETF Research Reports
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