Could previously unimaginable market events start to become more mainstream as the foundations for global stability dissipate and years of massive central bank intervention lose their firepower?
Gabriel Bouys / Agence France-Presse / Getty Images
How will the market perform over the next few months?
While every moment in history may still seem the most precarious to date, this year’s pandemic and unstable geopolitics may mean that 2020 is truly a special case. One of the many triggers over the next few months – a hard Brexit, a contested election in the United States, a COVID-19 vaccine failure – could cause the market to fall, like in early March. On the other hand, political responses, or good surprises, can trigger a merger, like the one that began in late March.
There might just be an ETF for it.
SPYC Simplify US Equity PLUS Convexity,
The exchange-traded fund, launched in early September, uses options to give investors access to the entire stock market, with protection against large swings in either direction.
“The question you need to ask yourself is what the markets will look like for the next six months or so, and whoever tells you they know how to lie,” said Dave Nadig, CIO and Research Director at ETF Database .
“Four or five years ago we all had a basic expectation, with some variation,” Nadig said in an interview. “We are now in a different type of market. Tails are becoming as likely as the central tendency. SPYC is a product specially designed for this world where the curve has been crushed, so that you can maximize the profit of the tails. “
Simplify is a new ETF issuer, but it was founded and is led by industry veterans including Paul Kim and Brian Kelleher, who both spent years at PIMCO, the massive asset manager known for his strategies. bond. The two want Simplify to be “the PIMCO of options,” Kim told MarketWatch.
The options strategy works like this: 98% of SPYC’s portfolio is invested in the S&P 500 SPX,
via iShares’ popular and inexpensive IVV ETF,
The remaining 2% are put and call options – financial instruments that allow the investor to sell and buy the underlying security at certain times in the future at predefined prices.
This 2% does a lot of heavy work. Puts offer protection against declines, helping to preserve capital, while calls protect against large upward movements. The greater the fluctuations in the market, the more these benefits accrue to the portfolio. (This is a concept in financial markets known as “convexity,” which is the “C” in the ETF symbol.)
What is the worst-case scenario for an investor in SPYC? One where the markets drift for a while and don’t go too far up or down. The 2% allocated to the options strategy would be wasted – $ 100 invested in the fund, say, would become $ 98.
Solving the two-tailed problem is not just a favorite project of the ETF industry. It’s a priority for advisers and investors, big and small, Kim notes. Stanley Druckenmiller, the former manager of the now billion-dollar hedge fund, told Bloomberg News in early September that the market was in “a rampaging fad” because of the Federal Reserve’s intervention. Inflation could soar by 5 or 10% over the next few years, he said – and yet deflation is just as possible.
SPYC’s bilateral strategy differentiates it from “low volatility” products such as the Invesco S&P 500 Low Volatility ETF SPLV,
and the iShares Edge MSCI Min Vol ETF USMV,
which received poor reviews for their performance during the March Mayhem.
It also differs from popular “defined result” products developed by companies like Innovator, which offer what Nadig calls “guardrails”. investors in these products forgo certain advantages in exchange for some protection against downside risk, and both parameters are known in advance.
Whether or not this is a much tougher time or an unfamiliar investment landscape is up for debate. But one thing is certain: the market context of 2020 adds an additional wrinkle.
Thanks in large part to central bank maneuvers in the wake of the coronavirus crisis, proven approaches to managing investment risk may no longer work.
Lily: The Fed will buy ETFs. What does it mean?
“We say bonds are just as risky now,” Kim said. “You get the cash back with interest rate and credit risk. Cash might even be less risky than bonds. ”
Valuations of TMUBMUSD10Y bonds,
are near historic highs and returns near historic lows. But transferring money to cash also comes with many risks: the S&P 500 is up more than 50% from its low at the end of March.
Other traditional safe-haven assets, such as gold, are also in demand, Nadig argued.
Meanwhile, he said, “We are more susceptible in this environment for the foreseeable future than in another because we have put forward so many decades of monetary policy. I think we have created so many pro-cyclical and reflective pockets of the economy that I would say black swans turn gray very quickly.
