Long And Short Funds, A Timely Strategy For High Volatility Markets

Many investors want only the highest long-term returns they can get. But what stock market volatility shows us is that that sooner or later investors’ risk tolerance drops, as market volatility climbs and investors’ stomachs get tight.

For that reason long-short funds deserve consideration.

Also, much of the investment capital in the market is retirement funds, from people either near or in retirement. For this, capital managers can’t keep having people’s portfolios blowing up. What distinguishes many long-short funds is that they are more adept at managing risk.

Long-short funds are designed to behave differently than almost all other funds. Through shorting, funds can appreciate when the market slumps, or at least decline less than the general market or other funds. In market rallies these funds will participate, though not as fully as long funds.

So long-short funds should not be as subject to market ups and downs, which we are having a lot of. Overall portfolio risk should be lessened, without giving up participating in market advances.

One long-short fund uses its volatility analysis to make portfolio choices, and also exclusively invests through ETFs. The Vireo Global Macro Allocation Portfolios ("GMAP") are designed for defensive minded investors seeking an investment strategy that has the ability to outperform in both advancing and declining markets. Navellier Associates, the $2.7 billion dollar manager headquartered in Reno, Nevada offers these two long-short funds.

The first GMAP Model is a fully diversified portfolio containing 9-12 positions. The second is a more aggressive portfolio, the GMAP Concentrated Model, which has 5-6 positions.

The portfolios are managed by the creators of the GMAP strategy, Tim Hope and Michael Garaventa. They generally take a broad ETF to go long, such as SPY SPY, one of the S&P 500 Indexes - then use more narrow ETFs, such as the PowerShares DB U.S. Dollar Bearish ETF UDN, as short positions to participate in what they see as declining asset classes. 

The GMAP portfolios are intended for investors seeking consistent long-term returns using a variety of asset classes that can produce positive performance in both up and down markets. In creating their portfolios the managers employ a ranking formula that they developed and have used for about 25 years.

The portfolios both have impressive backdated performances, both from an appreciation and from a lowered volatility standpoint. Information on both portfolios is at: http://www.navellier.com/individual_investor/pa_defensive.aspx

Navellier Associates GMAP attempts to have less volatility without giving up performance

GMAP uses a diverse list of ETFs, and for the short side uses a mirror image list of inverse ETFs, which are ETFs that profit from a decline in the value of the underlying index.

Investors know that it is possible to get investment returns in both rising and falling markets, and that shorting makes this possible. It is much more efficient to use inverse ETFs rather than stocks, because shorting stocks is inefficient.

One reason is that the asset class desired to be shorted might not have stocks available. Often there can be difficulty in borrowing the stock desired to be shorted, and there is the cost of margin requirements to put on short positions. Also adverse liquidity events, such as events in the companies whose stock is shorted or events in the sector of the shorted stock, might cause short term disruptions, causing ill-timed short covering.

With inverse ETFs there is no longer the execution problems related to borrowing and selling shares on an uptick. GMAP, through the use of ETFs, does not have to use options or futures. Trading in size is not a problem when using ETFs. If there are not enough shares to trade, through the creation process the ETF maker merely creates more.

Using the fear index, the VIX, for when to buy, sell, and short

There is much talk today about the “VIX,” and Hope and Garaventa use the VIX to measure when to buy and sell and what to buy and sell. VIX is the ticker symbol for the Chicago Board Options Exchange Market Volatility Index, and is a measure of the S&P 500 Index options implied volatility.  

It is sometimes referred to as the fear index because when it goes up, which shows higher implied volatility - trading is expected to also go up, and prices are expected to fluctuate wider.

As market volatility increases, the allocation to inverse ETFs increases correspondingly in the GMAP portfolios. From their universe of ETFs Hope and Garaventa use their proprietary process to break the ETF universe into three baskets of ETFs, which they then sort from the most attractive to least attractive. The most attractive ETFs are bought in the long portfolio while the least attractive ETFs are used in the inverse allocations.

ETFs that GMAP likes and doesn’t like now

GMAP is a believer in commodities, and has been long the PowerShares DB Commodity Index Tracking Fund DBC, as well as the PowerShares DB Agriculture Fund DBA. GMAP likes gold, and has been long GLD GLD, which is the SPDR Gold Trust.

“Interestingly enough,” Hope says, “the twenty-year Treasuries have worked out real well, even with yields this low.” There are many Treasury ETFs, including those on iShares.com or PowerShares.com.  

On the short side, Hope says that they are short the U.S. dollar and short emerging markets.

He says, “When you have all these troubles in Europe, all these uncertainties, many people have their backs against the wall. As investors, they say ‘what do I do, where do I go, the headline events are so outrageous, there are no yields as far as fixed  income, so what can I do?’”

Hope says that investors can turn to GMAP, and that even with the scary headlines there will be economic events to take advantage of. He says there will probably be higher agricultural prices, higher precious metals prices, and other eventualities that investors should take advantage of - and GMAP already has investment systems in place to take advantage of them.