Author: Brendan Ruchert-Dixon
Covestor model: Alpha Trapper
Disclosure: Long VTI, BLV ; Short TMV, PST
January Performance:
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Alpha Trapper Model: +1.08%
S&P 500: +2.26%
iShares Barclays 20+ Yr Treas. Bond ETF (TLT)*: -3.08%
Since inception (as of end of day 2/3/11):
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Alpha Trapper Model: +4.70%
S&P 500: +6.73%
iShares Barclays 20+ Yr Treas. Bond ETF (TLT)*: -4.29%
*Performance numbers for the model and S&P 500 come from Covestor. Numbers for TLT are calculated using the “Adj Close” column in the Yahoo Finance Historical Prices tables. The adjusted closing price for the final day of the month is divided by the adjusted closing price of the previous month for monthly data, or by the 12/2/2010 closing price for cumulative data. See important disclosures
January 2011 marked the first full month for the Alpha Trapper model. Many of the trends that were present in December continued through most of January, with stocks gaining while most bond yields rose. Since the model invests in both, it lagged the stock market a bit, but such is the price of diversification.
Not surprisingly during this rally, the strongest contributor to my gains has been VTI, the total market index ETF, which I’ve been keeping at around 50% in my long holdings. My biggest loser has been my short position in TMV (a 3x inverse 20+ year treasury ETF). Other bond holdings, such as my long position in BLV, have also lagged.
I don’t pretend to be able to predict where yields will go from here, but I do know that they won’t rise forever, and that by definition, the higher the yields go, the more those bonds can be expected to return in the future (barring default).
The model made a few moves this month:
One was to close out a small short position in VXX. VXX tracks near term VIX futures. The futures are usually in contango, so VIX tends to decay during most periods when the market is calm and/or rising, but can spike suddenly if volatility jumps. By mid-month, the VIX and its futures had dropped to levels that made me less comfortable about the risk/reward of holding a short position. I will be looking to short this again if/when volatility expectations rise again.
My other move was to open a short position in PST, a 2x inverse 7-10 year Treasury ETF. This supplements the short position I already carry in TMV (Direxion Daily 30-Year Treasury Bear 3X ETF). I was drawn to PST for several reasons:
1) Shorting an inverse treasury ETF gives the same leverage and diversification benefits as adding a long position in a non-inverse treasury ETF like TLT or IEF, but you don’t have to pay margin interest, and the expense ratio works for you instead of against you.
2) Like all leveraged and inverse funds, it decays during most periods when there is not a strong unidirectional trend.
3) “2x inverse” means there’s a built-in expected annual loss of twice the bond yield.
4) PST is a lot less volatile than TMV. The magnitude of its losses (or “gains” for a short) is lower, but upside risk is also much lower, so you can short more shares with relatively lower risk.
