Nadig: Hougan’s Misguided SPHB Pick

April 30, 2014

If you want higher-risk exposure on the S&P, SPHB isn’t really the best choice, Nadig says.

It’s not often Matt Hougan tees up a ball as nicely as he did in his recent blog running through forgotten and unloved funds.

I have to thank him for the slow pitch on the PowerShares S&P 500 High Beta Portfolio (SPHB | A-43). Matt points out that the fund does what it says on the tin:

“In the end, I like SPHB because it does exactly what it says it does: Provides high-beta exposure to the S&P 500.”

And I can’t disagree with that. The problem is that it turns out to hardly be the only—or even the best—way to achieve that objective. Going after “higher beta” from your S&P 500 exposure isn’t magical. The simplest way to do it is to use leverage. If I double down on the S&P 500 by buying 200 percent of my equity allocation in, say, the SPDR S&P 500 (SPY | A-98), well, congratulations, I’ve got a beta of 2.0 to the S&P 500!

And I did it all while maintaining precisely the same percentage exposures to various companies and sectors as my plain-vanilla investment.

But in reality, that’s not practical. Thankfully, the ETF market has found ways to bolt leverage (read, higher beta) into all sorts of products.

But before we get to that, let’s do away with one egregious piece of cherry-picking in Matt’s analysis. The previous one-year period has been an all-time historical outlier for rewarding the highest-risk stocks in the S&P 500. For a slightly more fair analysis, let’s look at SPHB since inception, not just since Matt’s magical bottom.

SPY_Vs_SPHB

Far from beating the pants of the S&P 500, in the near three years since inception, SPHB is in fact just under 30 percent, while the S&P is up almost 48 percent. High beta did exactly what you’d expect in 2011—it tanked, even harder than the S&P 500. In fact, from inception to the end of that year, SPHB lost more than 20 percent, while the S&P lost just under 4 percent. That’s client-losing missed performance, in my book.

But let’s imagine you were still a believer back in May 2011, when SPHB launched. What were your options? Since its launch, SPHB has had a beta to the S&P 500 of about 1.5, or, put another way, about a 50 percent leveraged bet.

Well, one option would be to go 75 percent long into a double-exposure levered S&P 500 ETF like the ProShares Ultra S&P 500 ETF (SSO). To maintain a constant exposure, of course, you’d need to rebalance every day, and you’d be paying a steep 90 basis points in expenses. Clearly, that had to be terrible, right?

Hardly.

 


Here’s what that portfolio looks like, using the Vanguard Short Term Government ETF (VGSH | A-99) as our cash proxy:

SPHB 75% SSO/25% VGSH
Return (since 5.11.11) 29.80% 70.70%
Standard Deviation 27.00 24.77
Downside Risk 19.70 18.26

 

The “crazy” levered strategy returned more than double the performance, with less risk! Crazy, I know. And if you think that’s cherry picking, even in the worst comparable period—the one Matt picked, of the previous 12 months—you end up with essentially on-par performance between the two.

But I’m not actually suggesting anyone’s going to do a daily rebalance of their leveraged positions for a long-term strategy. Instead, Barclays has a product that solves that problem for you, the Barclays Long B Leveraged S&P 500 TR ETN (BXUB).

I covered these products years ago when they launched. Using clever financial engineering, the leverage factor you get on the day you buy in stays intact for your holding period, though the leverage factor for new purchases changes every day. So how would you use BXUB in this case?

To match the 1.53 beta Matt would have had during SPHB’s run since inception, you need to start on May 12, 2011 with about 55 percent BXUB and 45 percent in cash, again, proxied by VGSH.

SPHB 55% BXUB/45% VGSH
Return (since 5.11.11) 29.80% 56.49%
Standard Deviation 27.00 18.25
Downside Risk 19.70 13.03

 

BXUB wins here for several reasons. As an ETN, it’s delivering precisely the promised return over the period, with the only slippage coming from its 75 basis point expense ratio. I also has no expense from managing swaps—a problem with many leveraged funds. Along the way, it too maintains precise exposure to the same individual company and sector dynamics of a vanilla S&P 500 investment.

After all, consider how different SPHB is from the actual S&P 500:

SPY-SPHB-HRA

Yes, a bit of a nerdy-eye chart courtesy of Bloomberg, showing the regression of SPHB versus SPY since inception. With an R2 of less than 0.9, SPHB is simply based on the true story of SPY, but hardly a mirror. A quick look at the Fit tab on SPHB’s fund report shows why. It’s loaded with midcap financials and consumer cyclical stocks—likely the first ones up against the wall in a downturn.

Look, Matt, I get it. Everyone likes a simple, fire-and-forget magic bullet that promises to make you money and keep you from losing your hair. But not only is SPHB not a free lunch, it’s not even the best lunch around, as long as you’re willing to do a little work.


At the time this article was written, the author held no positions in the securities mentioned. Contact Dave Nadig at [email protected].


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