The Trap In TRND’s Taxes

December 14, 2010

The new RBS trend-following exchange-traded note is either the dumbest product to hit the market in recent years or a clever solution to a taxing problem.

The premise of the new ETN—which comes with the grandiose name RBS US Large Cap Trendpilot Exchange Traded Note (NYSEArca: TRND)—is simple: It follows a classic 200-day-moving-average strategy as applied to the S&P 500. When the S&P 500 is over the 200-day moving average, TRND goes long the S&P 500; when the S&P 500 slips below its 200-day moving average for at least five days, it moves into Treasurys.

There is nothing wrong or silly with a 200-dma strategy. Plenty of investors use it, and it’s a nice way to limit risk in the market. Historically, this strategy performs well.


Index Comparison: 10/31/09 - 10/29/10

Source: RBS TRND Factsheet


Recent historical performance, however, is in the gutter.

It’s only really a good strategy if the market trends downward. Then, Treasurys are a better bet than the S&P.

But TRND has a couple of issues.

First is the fee: The ETN charges 1 percent in expenses whenever it’s positioned long the S&P 500, and 0.50 percent when it’s in Treasurys. That’s absurd. You can buy S&P 500 exposure in an ETF for about 0.09 percent, and short-term Treasury ETFs charge about 0.15 percent. How you get from those numbers to a 1 percent/0.50 percent fee just for trading a few times a year (at most) is beyond me.

The second issue is that it’s an ETN, and not just any ETN: It's an ETN from a bank that had to be bailed out to the tune of 45.5 billion pounds a few years ago. As with any ETN, the value of TRND depends entirely on the credit of the issuing bank, which in this case is the Royal Bank of Scotland. If RBS goes belly-up, TRND will lose all of its value.

So why would an investor pay 10 times the necessary fees and take on credit risk to buy a product that follows the simplest trading strategy in the world?

The answer is not what some reports would want you to believe, which is that outsourcing the trading strategy to a third party means that you will stick to the rules and not let your emotions intervene. That’s poppycock.

The answer is taxes. Trend-following strategies are notoriously tax-inefficient. They are designed to buy low and sell high regardless of the tax consequence, meaning these strategies regularly generate significant capital gains for investors.

But such a strategy most likely will not incur deleterious capital gains if the trades take place inside an ETN.


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