You don’t have to have read a lot of blog posts here to know that I am fascinated by portfolio construction evolution. For me that started as finding tools to layer in to help manage portfolio volatility. This has taken on a couple of added wrinkles in the last few years looking for bond proxies or more specifically, tools that behave like bonds used to behave as well as exploring ways to add crypto asymmetry in very small doses for clients.
I look at far more tools (funds) than I ever actually incorporate which is fine and for now, I’ve struck out finding a crypto product I’d use broadly for clients, but it is interesting research and fun for me.
This leads us to three new funds I stumbled across in the last couple of days.
The first one is the Global X Nasdaq 100 Collar 95-110 ETF (QCLR). The fund owns the Nasdaq 100 with an options collar with the objective of reducing volatility. An option collar is a strategy that sells a call option above the market price of the underlying which in this case is the Nasdaq 100 and buys a put option below the market price of the underlying. Specifically, with QCLR it sells a call that is 10% out of the money (above the market price) and buys a put 5% out of the money (below the market price). Owners of the fund will go along for whatever the ride might be within that 15% band and should be hedged out of anything outside that band.
This is similar to Buffer ETF but with those, you hedge out the decline up to the first 9% or 15% or whatever, that is the buffer, and then go along for the ride down once the market gets outside of that initial buffer. The upside is also capped in the Buffer funds just like QCLR. If the market ends up dropping 50%, you’d feel a lot more pain with the Buffer funds. That assumes QCLR works as intended. Obviously, if the market rockets higher then you’d miss out on gains above the cap imposed by the call options.
The second fund is the Global X Nasdaq 100 Tail Risk ETF (QTR). This is the second fund that I am aware of with the term ‘tail risk’ in the name. The first one is the Cambria Tail Risk ETF (TAIL) which is a client and personal holding. The two funds are very different. TAIL owns mostly Treasuries with a small allocation to S&P 500 put options. When the market goes down, the puts should go up in value and offset some of the decline endured by the typical equity portfolio. As an added benefit, the fund might also get a boost from rising Treasury prices depending on the particulars of the decline. TAIL is not an equity proxy.
QTR is an equity proxy. It owns the Nasdaq 100 along with put options that are intended to mute downside volatility when it happens. This is a similar strategy as the one used by the Simplify US Equity PLUS Downside Convexity ETF (SPD) which owns the S&P 500 with a put option overlay. You can read up on the two funds for the nuanced differences. SPB has been out for just under a year so it is tough to tell how well it would do versus unhedged exposure because the market has essentially gone straight up. Put options certainly should hedge a portfolio somewhat but buying either SPD or QTR is to do so without the benefit of a real-world application of their respective processes.
The last fund is not new but new to me, the NexPoint Merger Arbitrage Fund (HMEZX). Merger arbitrage is a long/short strategy that I have been a big fan of for many years. The Merger Fund (MERFX) has been a client and personal holding for many years. There are quite a few merger arb funds out there and if you look you’ll see quite a few different looking performance profiles within the niche. MERFX functions for me as a bond proxy. There’s no yield to speak of but it is very boring (very little volatility) and moves from the lower left to the upper right very gradually. It does not add outperformance except, hopefully during market declines. HMEZX came to my Your Source email. All advisors get inundated with salesy emails, I delete 99% of them without looking so not sure why I looked at this one but either way, the email pointed out that HMEZX has outperformed other merger arb funds. I didn’t check all the merger arb funds but it has certainly outperformed MERFX. In looking at a five-year chart comparing the two, it is clear that MERFX offers a smoother ride but that is not captured in the current readings of things like standard deviation and Rsquared as reported by Morningstar. I think that might be because MERFX has done relatively poorly for the last couple of months or so. Either way, I’m intrigued at first glance by HMEZX.
Finally, there was an article in Barron’s about outflows from ARK Funds, the fund company made famous by huge returns and CIO Cathie Wood. The article cites what amounts to investor impatience for outflows. To the extent impatience plays any role, all of the funds mentioned in this blog post need investors to be patient in order for the funds to “work.” In terms of the strategy funds above, they will not outperform in a raging bull market but that shouldn’t be why anyone owns them. You own them to service a specific function or out of a sense of game-over because your assets are sufficient for you needs and can dial down the risk and volatility of your portfolio.
The ARK funds chase heat, they are volatility. When you buy those funds, you are expressing a belief in Wood and her team, and you expect it to outperform more often than not. Who knows if going forward it will outperform more often than not but it is certain that no manager can always outperform just as no stock or index can always outperform. But that doesn’t mean it can’t go on to be a world-beater. In November 2008 I bought the Consumer Discretionary Sector SPDR (XLY) with an $18 handle for clients. Today it’s at $180. It’s been a world beater but there have been some serious declines on the way. If it continues to do well for another 13 years, great but there will be serious declines again. To get impatient with short term underperformance is a behavior that leads to potentially destructive results. Don’t do that.
Disclosure: one client owns an ARK ETF on a mandate they directed.