FactorShares Introduces Spread Trading In ETF Wrapper

February 28, 2011 by  
Filed under Commentary, ETF IPOs (New ETFs)

Last Thursday (2/24/11) a new sponsor arrived on the scene with a new breed of ETF.  Factor Advisors, a New York-based asset management firm, announced (press release) the launch of FactorShares, the first family of “spread” ETFs.  A spread is a type of trade in which one simultaneously holds both bullish (long) and bearish (short) positions in different securities or markets.

This strategy is often called “pairs trading” when executed with two individual stocks from the same or similar sector.  The objective is to capture the difference in performance, or the relative strength of the stronger stock.   I am a long-time practitioner of trading based on relative strength.  However, due to the nuances and costs of implementing the short side of the trades, my trades have tended to be on the long side.

The primary criticism of a long-only approach is that even the strongest securities can decline in a weak market.  There’s an old market adage that you can’t buy groceries with relative strength.  FactorShares is trying to make that adage obsolete.  Now, with a purchase of a single FactorShares ETF, you can simultaneously hold long and short positions in two market segments.  This gives you the potential to profit from an increasing performance spread between the two, even if both are trending downward.

The first five ETFs in this new family are FactorShares 2X: S&P500 Bull/TBond Bear (FSE), FactorShares 2X: TBond Bull/S&P500 Bear (FSA), FactorShares 2X: S&P500 Bull/USD Bear (FSU), FactorShares 2X: Oil Bull/S&P500 Bear (FOL), and FactorShares 2X: Gold Bull/S&P500 Bear (FSG).  Additional details for each product are provided below.

New sponsors and innovative ETFs typically have a tough time gaining acceptance by U.S. investors.  Often this is because the sponsor fails to explain their products.  Barclays IVO and Citigroup’s CVOL are two examples that come to mind.  The team at Factor Advisors seems to understand this obstacle and provides excellent educational information on their new website.  Some examples:

  • Introduction to Spread ETFs (pdf) is a primer that discusses how the mechanics of implementing spread strategies can be simplified and enhanced by using ETFs specifically designed for that purpose.
  • Introduction to FactorShares (pdf) is a brochure with an overview of spread trading, and discusses the benefits of using spread ETFs to implement spread strategies.

Beyond the educational materials is the 184-page prospectus covering all five new ETFs (pdf), and a short-form additional disclosure document for each.  The ETFs all have 2x in their names, and the literature often refers to the positions totalling 400%.  This is technically correct, but investors need to keep in mind they consist of 200% long and 200% short.

If the underlying markets were very similar, this approach might be labeled “market neutral” and have 0% theoretical market exposure.  However, these initial ETFs from FactorShares attempt to capture the spread between vastly different asset classes – ones with historically low correlation.  Therefore, the 2x description is appropriate.

Management fees are pegged at 0.75%.  However, the prospectus contains a breakeven table indicating that overall expenses (the investor breakeven point) are expected to range from 1.08% to 1.19%.  Before you complain about high fees, remember that positions totaling 400% of the NAV are being established, which works out to be less than 0.30% per 100% position.  This also includes the daily rebalancing, so a do-it-yourself approach is likely to be considerably more expensive.

FactorShares are available commission-free ETFs to clients of Interactive Brokers, helping to reduce overall costs further.  Potential investors need to keep in mind these are not intended as buy & hold investments.  The risks of leverage and daily leverage reset apply.  Shareholders should actively monitor and manage their holdings.

The five new FactorShares ETFs:

FactorShares 2X: S&P500 Bull/TBond Bear (FSE) is a leveraged spread ETF designed for investors who believe large-cap U.S. equities will increase in value relative to long-dated U.S. Treasuries.  FSE seeks to track approximately +200% of the daily return of the S&P U.S. Equity Risk Premium Total Return Index by establishing a leveraged long position in the E-mini S&P 500 Stock Price Index Futures and a leveraged short position in the U.S. Treasury Bond Futures.  Additional information located in FSE overview, FSE fact sheet (pdf), and FSE disclosure (pdf).

FactorShares 2X: TBond Bull/S&P500 Bear (FSA) is a leveraged spread ETF designed for investors who believe long-dated U.S. Treasuries will increase in value relative to large-cap U.S. equities.  FSA seeks to track approximately -200% of the daily return of the S&P U.S. Equity Risk Premium Total Return Index by establishing a leveraged long position in the U.S. Treasury Bond Futures and a leveraged short position in the E-mini S&P 500 Stock Price Index Futures.  Additional information located in FSA overview, FSA fact sheet (pdf), and FSA disclosure (pdf).

FactorShares 2X: S&P500 Bull/USD Bear (FSU) is a leveraged spread ETF designed for investors who believe large-cap U.S. equities will increase in value relative to the international value of the U.S. Dollar.  FSU seeks to track approximately +200% of the daily return of the S&P 500® Non-U.S. Dollar Index by primarily establishing a leveraged long position in the E-mini S&P 500 Stock Price Index Futures and a leveraged short position in the U.S. Dollar Index Futures.  Additional information located in FSU overview, FSU fact sheet (pdf), and FSU disclosure (pdf).

FactorShares 2X: Oil Bull/S&P500 Bear (FOL) is a leveraged spread ETF designed for investors who believe crude oil will increase in value relative to large-cap U.S. equities.  FOL seeks to track approximately +200% of the daily return of the S&P Crude Oil – Equity Spread Total Return Index by establishing a leveraged long position in Light Sweet Crude Oil Futures and a leveraged short position in the E-mini S&P 500 Stock Price Index Futures.  Additional information located in FOL overview, FOL fact sheet (pdf), and FOL disclosure (pdf)

FactorShares 2X: Gold Bull/S&P500 Bear (FSG) is a leveraged spread ETF designed for investors who believe gold will increase in value relative to large-cap U.S. equities.  FSG seeks to track approximately +200% of the daily return of the S&P Gold – Equity Spread Total Return Index by establishing a leveraged long position in Gold Futures and a leveraged short position in the E-mini S&P 500 Stock Price Index Futures.  Additional information located in FSG overview, FSG fact sheet (pdf), and FSG disclosure (pdf).

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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