How I Try To Assess New ETFs

Direxion has launched an interesting suite of relative value ETFs.

Direxion rolled out a suite of ETFs that offer single wrapper access to pair trades. A pair trade is going long one sector or segment or style or factor and so on and then going short something related. So an investor that thinks growth will outperform value could go long a growth fund and sell short a value fund and either profit on the spread between the two if they're right or lose that spread if they're wrong. It is a sophisticated idea and so being cautious makes sense as anything not simple can turn out to be problematic. Here is the suite from Direxion;

In the case of the Relative Weight ETFs the long side of the strategies will be 150% while the short will be 50% which should net out to 100% long. There are some rules of thumb for some of these pairs that might give an indication of when to buy what and they work except for the times that they don't if you know what I mean. One of the rules of thumb is that as the yield curve flattens, growth should outperform value due to the different ways these companies access capital (equity markets versus debt markets). That worked on this go around until about six months ago. The first chart shows SPDR Growth's (SPYG) relative performance versus SPDR Value (SPYV) and starting six months ago growth started to rollover versus value. It is difficult to know what the exact consequence might have been for RWGV (listed in the table) but I don't think it would have been that bad.

Cyclical versus defensives is interesting too. In RWCD tech is the largest long sector and healthcare is the largest short sector. Generally you'd expect defensive companies to lag until very late in the bull market but the chart comparing client holding iShares US Technology (IYW) relative to the Healthcare Sector SPDR (XLV) tells a more complicated story.

This relationship worked as expected coming off the bottom in 2009 but started rolling over long before the bull market ended...if it's even over yet.

​I am not certain, but I think the Relative Weight funds are likely to have a lower volatility profile than the broad market but I was unable to find anything in the literature that set an expectation on this point either way. Here then is a comparison of tech versus healthcare during this bull market, not relative to it.

In a typical bull market all the sectors tend to go up. Had RWCD existed ten years ago the short in defensives, well healthcare anyway, would have been a serious drag on returns.

The next chart captures iShares MSCI EAFE (EFA) relative to the SPDR S&P 500 (SPY) which is similar to the objective of RWIU. The time frame of the chart is most of the 2000's when foreign equities did very well and domestic equities were on a bumpy ride to nowhere.

During the last ten years though, domestic has trounced foreign. That pendulum will swing back the other way at some point and while there is no way to know when that will happen it will eventually and at that point RWIU should do well but if you can get that correct why not just buy a foreign fund because domestic could still go up even if it goes up less than foreign?

I do think there can be a way to implement this concept as a sort of satellite exposure in a portfolio that uses broad based ETFs however I would want to see how they actually trade in relation to the broad market and relative to the respective long exposures each fund takes to have some sort of expectation of how they will trade.

When I bought BTAL back in May for clients the fund had years of track record and so I felt comfortable with the expectation set by it's trading history. Similar to BTAL, if these funds can be used they are probably a little more tactical in nature. I know that I won't keep BTAL off the bottom of a legitimate bear market. I would expect it to lag or even go down (that's its history) coming off the bottom of a real bear market. To be clear while I do think a bear market started months ago that has not been proven correct, down 20% for a couple of hours doesn't meet the burden in my opinion.

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