Sunday, November 27, 2011

Hedge fund type ETF Strategies

Once the domain of sophisticated investors such as hedge funds, market- neutral strategy ETFs are now accessible to the retail investors. Although it will attract pension funds, hedge funds, and institutional investors. The ETFs are traded on the NYSE. 

What is this market-neutral theme? In short, investing long in one instrument while going short another, irrespective of market movements the spread should generate a profit. Ideally the two instruments should be negatively correlated. There are different variations of the theme based on the market sector (i.e. telecom), market index, exchange rate, rates, dollar weight, beta, size, and other factors. One example is the equity-pairing method. An investor could have gone long on Apple (AAPL) as the iPhone popularity surged while shorting Nokia (NOK) which has declined significantly. Although Apple operates other businesses besides cell phones, the chart below illustrates the negative correlation, and hence a hedge.  

Source: Google finance

The key weakness inherent in this strategy is the constant need to rebalance the portfolio to maintain the hedge. As transactions incur cost, this can be a significant impact on returns. Another transaction disadvantage is the creation of undesirable tax effects. 

Back to the ETFs. FFCM LLC is a Boston-based adviser running the QuantShares ETFs. Here is a short spot on them ringing the NYSE opening bell:

They offer 7 variants of the theme:

(1)  U.S. Market Neutral Momentum Fund (MOM)

(2)  U.S. Market Neutral Value Fund (CHEP)

(3)  U.S. Market Neutral High Beta Fund (BTAH)

(4)  U.S. Market Neutral Size Fund (SIZ)

(5)  U.S. Market Neutral Quality Fund (QLT)

(6)  U.S. Market Neutral Anti-Momentum Fund (NOMO)

(7)  U.S. Market Neutral Anti-Beta Fund (BTAL)

These funds have just started so let's see how they will perform. The current economic backdrop will provide a good stress test. 

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