130/30 – A lot of fuss for an extra half-a-percent

Posted on: February 24, 2010 in: Uncategorized with 0 comments

Horizons Alphapro recently launched its S&P/TSX 60 130/30 ETF (Ticker HAH on the TSX). Horizons has a whole suite of leveraged ETF products like the S&P TSX60 Bull ETF (HXU). This new ETF adds a twist to the suite. The 130/30 of the title refers to the strategy of short-selling expected “losers” and overweighting expected “winners”. Here’s how it works:

Every TSX 60 company has a official weight in the Index. HAH’s manager will select 10 “losers” to underweight by 3% each relative to the offical weight. The money saved by reducing or “short-selling” the losers will be applied to 10 selected “winners”. Each winner will have its weight increased by 3% relative to its official weight. Other “neutral” companies will get the official weight.

Company Index Weight Adjust Net Weight
Loser #1 5% -3% 2%
Loser #2 3% -3% 0%
Loser #3 2% -3% -1%
Winner #1 4% +3% 7%
Winner #2 3% +3% 6%
Winner #3 2% +3% 5%
Neutral #1 2% +0% 2%

The result is that for every $100 invested, HAH could have up to $130 of positive “long” exposure and up to $30 of negative or “short” exposure. In practise, the ratio will be closer to about $120 long and $20 short, since each Loser’s Index Weight less 3% will always be more than negative 3%.

Winners and losers are selected each quarter by “applying an analytical quantitative and qualitative ranking and weighting process”, according to Horizons AlphaPro.
Here’s a chart of HAH and XIU, the plain-vanilla S&P TSX 60 ETF over the past five years. HAH is based on back-test data provided by Horizons.

I found that while HAH does offer a slightly better return than XIU, that comes with slightly higher risk and a much higher expense ratio (see the table below). In fact, after subtracting the additional expense of 0.78% from HAH’s excess annualized return of 1.3%, I’d have an extra half-a-percent in my pocket. Not terribly exciting, given all the effort and fuss. Nor is HAH any less risky with annualized volatility in the low 20% range right next to XIU. Another risk measure – drawdown – which measures the drop from peak to trough, is also the same at about 50%. Could it be that for all HAH’s bells and whistles, in actual performance there is no material difference?

Add to that the uncertainty of how effective HAH will be in implementing the long/short strategy. Leveraged ETFs, Horizons’ included, are often criticized for not delivering on promise when investors hold them for more than a week or so. (For more on that, see here and here.) This has to do with the way derivatives like futures are used to gain leverage. The HAH prospectus says the ETF could also use derivatives to manage its exposures, so will it suffer the same problem? For the answer to that, we’ll have to wait and see.

Your questions and comments are always welcome.
Until next time,
Vikash

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