The PowerShares S&P 500 Downside Hedged Portfolio (PHDG) was launched December 6, becoming the first ETF to be both actively managed and indexed. The fund uses an absolute return strategy that seeks to achieve positive returns in rising or falling markets not directly correlated to equity or bond markets. PHDG employs a quantitative, rules-based strategy designed to provide returns that correspond to the performance of the S&P 500 Dynamic VEQTOR Index.

The underlying index provides investors with broad equity market exposure with an implied volatility hedge by dynamically allocating between equity, volatility, and cash. The index allows investors to receive exposure to the equity and volatility of the S&P 500 Index in a dynamic framework.

Volatility exposure will be obtained through VIX futures contracts, VIX ETFs, and VIX ETNs. Creations and redemptions will be handled principally for cash, rather than in-kind exchanges, possibly making the fund less tax efficient and more prone to tracking error.

PHDG has an expense ratio of 0.39% and 503 holdings. Current allocations provide 86.1% exposure to the S&P 500 and 13.9% to VIX futures. Additional information is located in the overview, fact sheet (pdf), and prospectus (pdf).

Analysis/Opinion: This marketing literature appears to leave a lot to the imagination. Historically, every ETF has been either passively indexed or actively managed. The primary marketing literature does not provide any explanation of how PHDG accomplishes the feat of being actively managed while tracking an index. Only by digging in the prospectus, which most investors are loath to do, does one learn that “the fund will be actively managed and can have a higher or lower exposure to any component within the Benchmark at any time and also may invest in securities not included in the Benchmark.” Examples of securities outside the Benchmark include VIX ETFs, VIX ETNs, and E-mini S&P 500 futures.

The rules based methodology of the underlying index is also not described, but one of my previous articles provides an overview of the S&P 500 Dynamic VEQTOR Index. PHDG is not the first product to track this index. That honor goes to Barclays ETN+ S&P VEQTOR ETN (VQT), which was launched in September 2010 with a 0.95% investor fee.

PHDG’s advantages include a lower expense ratio and an ETF structure versus the credit risk that is inherent in the ETN structure used by VQT. However, VQT has the advantage of having no tracking error and a two-year track record. Both products will be included in the Alternative Strategies category of the ETF Field Guide.

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.