New Active ETF Mixes Safety And Risk

WBIG hedges in some areas and bets big in others.

WBIG hedges in some areas and bets big in others.

Last month, WBI Shares launched a suite of actively managed ETFs. As a group, these funds aim for a measure of capital preservation or downside protection along with price appreciation or upside participation. The suite garnered immediate attention from its huge initial asset inflow of about $1 billion total and from lofty price tags (for ETFs) of roughly 100 bps each.

A peek under the hood of one of them—the WBI Large Cap Tactical Yield Shares ETF (WBIG)—provides insight into a bold mix of risk reduction and active equity exposure.

Taming Equity Risk

Active ETFs offer one ironclad advantage over active mutual funds and even some passive ETFs: daily disclosure of the portfolio. In short, active ETFs must show their positions every day. That’s a huge plus because it provides current and prospective investors with a timely snapshot of the manager’s positions.

A peek at WBIG’s basket as of Sept. 10, 2014 shows their approach to downside protection.

First, the fund has a huge cash position—more than 20 percent in a short-term Treasury vehicle. Given today’s rates, the T-bill stake isn’t there to meet the fund’s yield objective, nor is it there as collateral for a derivative (more on options in a moment).

A large cash stake will definitely dampen equity market risk, and many managers are talking about taking a few chips off the equity table. Some folks might not want to pay 100 bps for a sizable cash stake, while others may find great value in reducing exposure when markets could be overbought—and paying someone else to make the call and execute to boot. For WBIG investors, the takeaway is that the fund’s managers aren’t shy about playing defense with cash.

Second, the fund holds two bond ETFs, totaling about 4 percent: the Vanguard Intermediate-Term Corporate Bond ETF (VCIT | B-57) and the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD | A-68).

These positions, while small, should also dampen equity risk while pulling their weight from a yield point-of-view. They also show that the managers have a long leash when it comes to asset selection: They can—and do—dabble in bonds.

Third, the fund holds put and call options. While derivatives call to mind horrible outcomes like the London Whale debacle, their use here seems clear: a risk-taming collar on underlying stocks.

The fund’s BestBuy collar keeps the effective range of the stock (currently at about $32) between $28 and $36. The fund has collars on three of its 20 stocks—including ironically, J.P. Morgan. To me, collars exemplify the true nature of downside protection: You have to give up something to get it. With the collars, the managers give up some upside for the three stocks plus any net cost of the options.

All of the above shows up in daily holdings. While investors may not want to check positions every day, they might want to drop in from time to time to see the size of the cash stake at least. Note: What doesn’t show in holdings is the funds’ sell discipline, another facet of its downside protection.

Work Hard, Play Hard

The fund’s holdings aren’t confined to avoiding losses. It’s taking plenty of equity risk—active bets away from the market portfolio. These include:

Concentration Risk

As mentioned above, WBIG currently only has 20 names in it. Our benchmark has over 1,100. Takeaway: Moves in a handful of stocks will drive performance, for good or for ill.

Sector Risk

With just 20 names, it’s hard to maintain a marketlike sector balance, which is not a fund objective anyway. Still, WBIG has 3x the market’s consumer cyclical exposure while entirely ignoring tech and health care.

Note too that cyclicals—heavily favored by the fund—are hardly a defensive play. Still, the fund’s current biases now aren’t the point, which is that WBIG can—and likely will—gain or lose relative to the market based on sector trends.

Overlap Risk

This risk comes in two flavors; the first is definitional. The fund has broad latitude to hold stocks outside the U.S., including emerging market securities. Yet the current alignment is all U.S. This variance, along with the bond exposure, makes it harder to park in a portfolio with traditional boundaries: Treat it as a global fund, and you’ll have huge gaps in international exposure. Treat it as a U.S. fund, and you’ll have too much ex-U.S. exposure if the managers rotate beyond our shores.

The second flavor of overlap risk is with firm size, and frankly, it’s just sloppy in my view. Seven of the 20 stocks in WBIG—a large-cap fund—also show up in their small- and midcap offering, the WBI SMID Tactical Yield Shares ETF (WBIC). Investors who like the WBI Shares premise—and clearly many do, given its $1 billion in assets—get an extra helping of these stocks in an already concentrated portfolio.

WBIG and its sister fund’s hybrid mix of safety and risk differs greatly from the tightly defined, dirt-cheap market exposure provided by leading cap-weighted index ETFs. While owning uber-efficient “dumb-beta” funds was hugely rewarding in 2013, marketlike performance devastated many nest eggs in 2008, which may explain the funds’ appeal. I look forward to watching how these funds perform going forward.

At the time this article was written, the author held no positions in the security mentioned. Contact Paul Britt at [email protected] or follow him on Twitter @PaulBritt_ETF.