VQT: S&P 500 With A Volatility Hedge

Barclays yesterday (9/1/2010) launched the Barclays ETN+ S&P VEQTOR ETN (VQT) exchange-traded notes (ETNs) that are linked to the performance of the S&P 500 Dynamic VEQTOR Total Return Index (press release).

Barclays takes “dynamic indexing” to a new level with VQT.  The underlying index can be dramatically reconfigured on a daily basis and employs a stop-loss mechanism.  The underlying index seeks to provide broad U.S. equity market exposure with an implied volatility hedge.  It will dynamically allocate investments among three components: equity (S&P 500 Total Return Index), volatility (S&P 500 VIX Short-Term Futures Index), and cash.

The VQT overview page and VQT fact sheet (pdf) provide the investment philosophy behind this product:

“the volatility component of the Index is premised on the observation that, historically, volatility in the equity markets tends to correlate negatively to the performance of US equity markets. In addition, rapid declines in the performance of the US equity markets generally tend to be associated with particularly high volatility in such markets. The Index, therefore, seeks to reflect such historically observed trends by allocating a greater proportion of its notional value to investments in the US equity markets during periods of low market volatility with the ability to allocate a greater proportion of its notional value to investments in a reference asset that tracks implied volatility during periods of high market volatility.  The Index also incorporates a “stop loss” mechanic that shifts the entire value of the Index to an interest-bearing cash investment under certain circumstances.”

 

The S&P 500 Dynamic VEQTOR Total Return Index

Barclays has demonstrated its ability to design and deliver products that can accurately track an index after fees (a 0.95% investor fee in this case), so the key to understanding VQT is to understand the index.

On any index business day, the index allocates weightings to the equity and volatility components based on a combination of realized and implied volatility.  The maximum weighting of the volatility component is 40%, and the combination of the equity and volatility components are typically 100% of the notional value of the index (no leverage) and 0% if a stop-loss event has occurred.

The stop-loss feature will allocate into a 100% cash position if the value of the Index has fallen greater than or equal to 2% over the preceding five days.  Since the stop-loss criteria is determined from the index itself, the move to cash can be as short as one day and a maximum of five days since being in cash for five days guarantees that the five-day return is greater than a 2% loss.

Index calculation is a 4-step process:

1. Determine the Realized Volatility
2. Determine the Implied Volatility Trend
3. Determine the Target Weightings of the Equity Component and Volatility Component
4. Evaluate Whether a Stop Loss Event Has Occurred

The following table is part of the prospectus and shows the 15 combinations of realized and implied volatility and the resulting allocation between the equity and volatility components.

When not in a cash override stop-loss condition, the volatility component can range from a low of 2.5% to a maximum of 40%.  Additional details on the index calculation methodology are in the VQT prospectus and pricing supplement (pdf).

Investors could potentially implement this strategy on their own using the SPDR S&P 500 (SPY) and iPath S&P 500 VIX Short-Term Futures ETN (VXX), but I wouldn’t recommend it.  The daily slippage, commissions, and overnight gaps are likely to induce extreme tracking error into any do-it-yourself implementation, not to mention the time and effort involved.

VQT has the potential to be a great product.  Investor education is likely to be the largest hurdle at this time, and I would advise anyone to understand this product before buying it.  It also has the negative characteristic of credit risk that comes with all ETNs.  Barclays also needs to work on a consistent marketing message because once again they avoided the iPath brand for VQT.

Disclosure covering writer, editor, and publisher:  No positions in any of the securities mentioned.  No positions in any of the companies or ETF sponsors mentioned.  No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.

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For-Profit Education, China-style (EDU)

August was ugly for most market sectors – the dollar may have been the only safe place.  One group of stocks bludgeoned in a particularly nasty way was U.S. for-profit education stocks.

Companies like Apollo Group (APOL), Corinthian Colleges (COCO) and Strayer Education (STRA) were first hammered on news that their graduates are significantly more likely to default on federal student loans than alumni of traditional four-year colleges.  Then Barron’s quoted an analyst saying the Department of Education’s estimates are probably accurate, bringing more pain for these stocks.

Worse yet, for-profit education stocks are a subsector of the consumer discretionary space.  In this market environment, consumer discretionary names are tough bets from the long side.  Even so, there is opportunity among for-profit education names.  You just need to look outside the U.S. to China.

Consider New Oriental Education (EDU).  EDU is a Chinese provider of foreign language training, test preparation services and software products.  Shares of New Oriental were up slightly last month while the U.S.-based education stocks were deep in the red.

On a fundamental basis, there is a lot to like with New Oriental.  China takes education seriously.  As the country continues to boost its presence on the global economic stage, more Chinese citizens will need to learn foreign languages.  This will boost demand for New Oriental’s services.

The smart money crowd apparently likes New Oriental as well.  Second-quarter 13F filings show that the stock is among the favorite Chinese American depositary receipts owned by professional money managers.

To be sure, New Oriental is no stodgy blue chip.  This is a growth stock with growth stock traits.  The market cap is just $3.73 billion, putting New Oriental barely into the realm of the mid-cap universe.  Its trailing P/E is over 49, the forward P/E is over 28 and shares trade at almost 9x book value.  Year-to-date, the shares are up more than 30%.  That compares with a loss of 5% for the iShares/FTSE Xinhua China 25 Index Fund (FXI).

Recent performance underscores how New Oriental is a preferred option in the for-profit education space.  It’s also one of the better bets among all U.S.-listed Chinese stocks.  New Oriental may face some near-term headwinds simply because of negative market sentiment, but support for the stock seems firm at the 50-day moving average.  If EDU can hold the $97-$100 range heading into the fourth quarter, it could find its way above $110 by the end of this year.

To play the always-optimistic Chinese education market in a difficult year, go with EDU. All the best.

Disclosure covering writer, editor, publisher, and affiliates: No positions in any of the securities mentioned. No positions in any of the companies or ETF sponsors mentioned. No income, revenue, or other compensation (either directly or indirectly) received from, or on behalf of, any of the companies or ETF sponsors mentioned.

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Tracking the Walking Dead of the ETF World

Rhonda Schaffler of Reuters Insider TV interviewed me recently for a segment entitled Tracking the Walking Dead of the ETF World.  The story aired on August 23, 2010.

We discussed the exploding number of new ETFs and ETNs coming to market and how I identify the potentially troublesome products included in ETF Deathwatch.  We also covered the reasons investors should be cautious of low-liquidity funds with some specific examples.

Here’s a link to the video: http://link.reuters.com/cet27n

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Should You Retire Abroad?

A key factor in retirement happiness is where you retire. Familiarity, the relationships, and other factors tend to keep us planted at home when we retire.  Most American retirees plan to spend their leisure years somewhere in the United States.  However, a stateside retirement is not the only option.

If the size of your nest egg is a concern for you retiring comfortably in the United States, you might consider a place where your savings can go much further.  You know how much things cost in the US – but did you realize there are places where your dollar can go up to 4 times further?

You don’t have to go to the “Third World “ or give up all the comforts of America.  Many foreign retirement destinations have Internet connectivity, satellite TV, golf, beachfront property, and other amenities you are accustomed to – at a deep discount.  Granted, you may be a couple of plane trips away from the U.S., but the cost savings and new adventures may be enough to overcome any inconvenience.

For example, US News recently highlighted a couple, Jason and Elizabeth Pearce, who retired to Belize.  The Pearce’s live on Jason’s Social Security alone, allowing Elizabeth’s to go into savings.  They have a house on the ocean, a maid, a gardener, the Internet, and have made new friends.  They are enjoying a far more comfortable retirement than they could have afforded in the U.S. or Canada.

Here’s the sample budget for the Pearce’s in Brazil:

• Rent: $300
• Utilities, telephone, and Internet: $500
• Groceries: $150
• Health insurance: $50
• Entertainment: $100
• Car expenses: $300

However, Belize is not the only country that offers cheap living with home style amenities.  Other popular expatriate destinations abound in Latin America: Chile, Costa Rica, Ecuador, Guatemala, Honduras, Mexico, Nicaragua, Panama, and Uruguay.  Granted, you may need a few Spanish classes before you go, but it’s a small price to pay.

If you’re feeling more adventurous, look to a different hemisphere. Cambodia, Laos, Malaysia, Philippines, Thailand, or Vietnam all offer a similar experience to retirees, but in a less-familiar environment.  English will be spoken less in these areas, but that’s a challenge met by most retirees going abroad.

Before you buy plane tickets, do some planning.  Consider healthcare coverage, cultural differences, and the differences in legal systems.  Check out Retired Expat for more information on foreign living.  They cover a variety of overseas retirement issues if you’re considering that route.  For a more luxurious experience, you can always subscribe to one of the pioneers in the overseas living arena: International Living.

Living abroad is certainly not for the majority of folks looking to retire, but for a select few, it could be a great way to reduce your cost of living while providing a brand new adventure in retirement.  Just be sure to pack the sunscreen.

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