Negative Correlation Between the S&P and Treasuries? Factor Advisors CEO Stuart Rosenthal

We spoke with Stuart Rosenthal, CEO of the New York-based asset management firm Factor Advisors, on his firm's analysis of an emerging negative correlation between the S&P and US Treasury bonds and the FactorShares family of ETFs, a double-leveraged group of assets designed to allow investors to play the relationship between T-bonds and the S&P. Rosenthal discusses the Factor ETFs, which are designed to give investors the ability to trade the spread between the two asset groups. Partial transcript below. How do these products work?

"Factor Shares is the first family in the US for spread-based ETFs. By spread-based ETFs, we simply mean they provide long exposure to one market segment and simultaneous short exposure to another market segment all within a single ETF. Specific to the S&P 500 and US Treasury bond market segments, we have two ETFs: one being the FSE, which is FactorShares 2x S&P 500 Bull/T-bond Bear, and the other one is the opposite. FSA is the FactorShares 2x T-bond Bull/S&P 500 Bear, and as you might expect this is for investors that are bullish on US Treasury bonds and bearish on the S&P 500."

There is an emerging negative correlation between these two markets, correct?

There is. For the two market segments S&P 500 and US Treasury bonds, what we are observing is a very negative correlation or a relationship such that when one market segment is moving higher there is a very high likelihood that the other market segment is moving lower. This has become a familiar pattern for investors for much of this year, but in particular for the last 3 months we observing this correlation as being at a near-record -.84. Based on our data, that is a multi-year if not a multi-decade low."

What was the idea behind the genesis of these products?

"The idea behind the products was to provide for these dual exposures, these long and short exposures, for investors within a single ETF and all based upon a passive or index-based approach. The spread trading concept is something that's been around for many decades, and it's a sophisticated strategy to be sure, but not unlike a lot of ETFs that have appeared in recent years, we want to provide access for a broader swath of the market place. The structured ETF platform is something that investors have increasingly embraced in recent years. We thought spread trading, within an ETF, under the FactorShares brand was the way to go."

So the correlation is at a multi-year low. What does that do for the price action of the ETFs?

"For the FactorShares ETFs, because they're a long short type of implementation, when you have this situation where the correlation is negative between your long and short positions, the overall volatility of the ETF increases. We would say that the spread is more volatile as a result of this high negative correlation."