Do Not Buy SPGH
A new exchange-traded product hit the market yesterday (January 28, 2010): UBS E-TRACS S&P 500 Gold Hedged Index ETN (SPGH). If this sounds like something you might want to buy, I suggest you understand what it really is and compare it to a Do It Yourself (DIY) solution before plunking down your cash.
Here is the official description: UBS E-TRACS S&P 500 Gold Hedged Index ETN (SPGH) seeks to simulate the combined returns of investing equal dollar amounts in the S&P 500 Total Return Index and long positions in near-term exchange-traded COMEX gold futures contracts, and is rebalanced monthly.
I believe that description is very misleading as it sounds like SPGH will have 50% exposure to the S&P 500 Total Return and 50% exposure to gold futures. However, that is wrong. The two positions will not be weighted at 50% each – they will be equally-weighted at 100% each. SPGH will have 100% exposure to the S&P 500 Total Return while simultaneously having another 100% exposure to gold futures.
In futures trading, this is what is known as an overlay. SPGH is a security providing 200% long exposure since every dollar you put in will generate $1 exposure to the S&P and $1 exposure to gold futures. Where are the regulators when you need them? Shouldn’t the SEC make them disclose this fact using language retail investors understand? And shouldn’t UBS be concerned about a potential shareholder lawsuit if SPGH doesn’t match investor’s expectations?
According to the SPGH summary page, the ETN is designed to provide exposure to the S&P 500 Total Return Index, along with a potential hedge against periodic declines in the value of the U.S. dollar, as expressed in the corresponding increases in the price of gold.
Since the ETN is essentially 200% long, simultaneous 50% declines in the S&P 500 and gold could potentially send the value of SPGH below zero. UBS has partially prepared for that with an “Early Termination Event” that will be triggered if the closing indicative value is at or below $5.00, which is an 80% decline from the offering price.
The prospectus contains additional surprising information, such as the 1% sales commission: “We intend to sell a portion of the Securities on the Initial Trade Date for a price equal to 101% of their stated Principal Amount. Dealers purchasing as principal will receive a commission of 1% of the stated Principal Amount of the Securities and we will receive net proceeds of 100% of the stated Principal Amount of the Securities.”
To get a better understanding of what this product really is you need to also study the underlying index, the S&P 500 Gold Hedged Index. This document contains the backtested results covering the 10-year period from 10/31/1999 through 10/31/2009.
I ran my own backtest, which I will refer to as the DIY approach. The DIY backtest covers the same 10-year period and uses the same monthly rebalancing assumptions. However, the DIY approach is different in that it uses no leverage and no futures. Instead, 50% is invested in the S&P 500 Total Return and 50% in gold bullion. An investor could easily replicate the DIY approach using S&P 500 SPDR (SPY) and SPDR Gold Trust (GLD) ETFs.
The results in the table below compare S&P’s Index Backtest results on the underlying index to my DIY Backtest approach and to the S&P 500 Total Return.
|SPGH vs. DIY||Ann. Return||Ann. Volatility||Correl. with S&P 500||Sharpe Ratio|
|* 3-Year Performance|
|S&P 500 TR||-7.0%||29.8%||1.00||-0.33|
|* 5-Year Performance|
|S&P 500 TR||+0.3%||24.0%||1.00||-0.12|
|* 10-Year Performance|
|S&P 500 TR||-0.9%||22.3%||1.00||-0.18|
The Index Backtest data does not include maximum drawdown information but it appears to be in the neighborhood of -60%. The maximum drawdown for the DIY approach was about -34% and the S&P 500 TR was -55%.
The backtests assume monthly rebalancing, which can be onerous for individual investors. I ran additional DIY backtests assuming quarterly and annual rebalancing without much difference in the results. The 10-year DIY with annual rebalancing produced +6.8% annual return, 13.9% volatility (standard deviation), correlation of 0.67, and a Sharpe Ratio of +0.26.
It is not my intent to address the merits of a strategy that holds equal positions in stocks and gold. Whether or not you want to pursue such a strategy is your decision to make. My only suggestion is that if you do choose to pursue such a strategy, you should consider something other than SPGH.
Perhaps there may eventually be some market conditions where SPGH would be superior, but for my money, the DIY approach would be the preferred solution. The risk-adjusted return is better for all time periods shown. Furthermore, the DIY approach does not have the additional risks of dealing with 200% exposure, with the ETN format, or with the little known E-TRACS product line.
Disclosure covering writer, editor, publisher, and affiliates: Long GLD. 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.