Forget Evolutionary, This Could Be Revolutionary

IndexUniverse has a post up about an ETF filing from a firm called FactorETF that could be huge. The basic idea is that the ETFs would capture performance dispersions between different asset classes or different segments of the stock market. The filing appears to be for 22 funds.

There is one fund listed that captures 200% (they are all levered) of the difference between US value over US growth and then one that captures the difference between US growth over value.There are similar pairings between large cap and small cap, US and developed foreign and US and emerging markets. There are three funds that capture the excess return (or lack thereof) of a US sector over the broad domestic market and two similar funds for groups of stock over the broad market. There are pairings for stock versus government bonds, plays on the yield curve, credit spreads and inflation versus bond yields.

These funds, if any of them actually list (sorry to be negative but look at page two of the ETFWatch on IndexUniverse), offer a tremendous step up in portfolio sophistication for certain types of hedging. For example for a period last year certain foreign stocks lagged domestic because of a panic rally in the dollar. The FactorETF 2x Non US Developed Factor Shares could help offset this. The yield curve products could be especially helpful now given the likelihood of higher rates coming down the road. The FactorETF 2x Financial Factor Shares could be a way to buy into the sector without buying the sector. Making a couple of assumptions, someone nimble enough to have bought financials in March could have bought a small position in 2x Financial Factor Shares which would have gotten progressively bigger in the portfolio as the sector began to rocket higher ahead of the market.

There are caveats galore here. First, this is just a filing who knows if any of these will ever list. If any of them do come to the market I would give them quite a few months to show how they actually trade. There is a lot of learning that needs to be done between this post and actually buying one of these in terms of strategic implications in addition to whether these funds would actually work. The biggest caveat is anyone who would consider using these, and they will not be right for everyone, would be advised to do so in moderation.

Assuming they work, I would still prefer SDS (clients have a small position in this now) for the bulk of my bear market hedge. The Factor equity funds would have more application in mitigating the consequences of getting things wrong like growth versus value for people that invest that way and so on. They could go up in a bear market as growth might drop 2% one day and value 3% so the growth fund would be up but you know SDS will go up on a down day.

Part of my first reaction is to compare these proposed funds to the ones from IndexIQ. They have two ETFs trading; a multi hedge fund strategy ETF (QAI) and an emerging market macro ETF (MCRO). You can look at the full list from IndexIQ here. I'm a tad underwhlemed by QAI and MCRO but maybe some of their proposed arbitrage funds could be useful.

Hopefully these funds list and we can have a more productive look at these.