A Better SPY?

| | Investment Strategies

Index investing is all the rage now with over a trillion dollars invested in the SPY and VOO ETFs alone.  The expectation is that low fees coupled with broad market exposure is better for your portfolio than an actively managed strategy with higher fees. One could argue that as the components of the indices attract more of the capital flow that these names really do drive the market and even a “diversified portfolio” often correlates highly to a simple index. I believe strongly that everyone should have some equity exposure but is there a better way to do it?

Futures managers often design their programs for absolute returns that provide a complement to the traditional model portfolio. Trend followers, as an example, often achieve their highest returns in times of high volatility (equity losses) as many sectors move consistently in one direction over a period of weeks and months. One area we rarely see CTAs engage is a pure competition against the S&P 500 to see if the versatility and margin benefits of futures contracts along with different timing strategies can beat the index on an absolute return and risk adjusted basis.  After all, if you could have the same investment with lower volatility that would be a no brainer.

Three programs on our site take different approaches to this challenge. Goldman Management typically runs his strategy at a lower level of volatility than the index itself and avoids using leverage entirely (when fully funded).  Positions are held for long periods with limited turnover in the portfolio.  In some instances, the trader would go short but often just reduces exposure when the market is falling. This has led to lower drawdowns since inception than the S&P and quicker recoveries.  The trader uses deep market research to identify when to be fully allocated or partially allocated.

Covenant Capital Management’s Hedged Equity Program takes a different approach.  They look at the potential for wealth destroying drawdowns (greater than 10%) and seeks to reduce or eliminate them entirely through a systematic hedging process. We can look at the “Dot.com” crash in the early 2000s or the housing crisis in 2008 as two or the more recent examples of extended down periods for stocks. From peak to valley, each took over 5 years to recover their high point.  A scary prospect for someone planning to retire in the near future as the chart shows these losses occurred back-to-back equaling 11 years of flat performance.  While the program officially launched in 2020, it got its first test almost immediately and showed its ability to negate a loss and turn it into an opportunity as COVID panic spread through the markets.  Unlike Goldman, they trade their program at 1.8x leverage ($100k invested equals $180k exposure).  They believe that the ability to play defense gives them freedom to be more aggressive with their market positions and be more cash efficient than a traditional ETF.

 

SP500 NAV

Past Performance is not indicative of future results.

Lastly, Agility Trading created a program that also holds a dedicated long S&P position without leverage and added a shorter-term trading system on top of that that focuses on negative correlation to the equity markets. The idea matches that of many futures programs, providing the potential for “crisis alpha” that will benefit a traditional portfolio when it needs it the most.  Here it occurs all in one investment.  This system is always on and has turned some negative periods into winners thus far.

Time will tell if commodity trading advisors can break into the equity market to compete with the largest ETFs in the world. These three traders show that it is possible to overcome the fee hurdle and succeed.  It only takes avoiding one big loss every few years to pay off.