ETF Of The Week: Tail Risk Fund Flying High

December 28, 2018

Target-outcome ETFs, which attempt to deliver a specified return no matter what the market is doing, are designed to keep investors on track with their goals, whatever those may be. But when the market tanks, some target-outcome ETFs work better than others.

In fact, of the 55 target-outcome ETFs, only one fund is ending the year in positive territory: the $32 million Cambria Tail Risk ETF (TAIL).

Over the past 12 months, TAIL is up 11%. Meanwhile, its next nearest competitor, the $106 million WBI BullBear Global Income ETF (WBII), is down 1%.

Riding Tail Risk To Profit

Until recently, however, TAIL was significantly underperforming the S&P 500. It was only when the stock market started to plummet earlier this month that TAIL began to soar:

 

Source: StockCharts.com; data as of Dec. 27, 2018

 

It's hard not to notice in the above chart that for every major slide the S&P 500 has seen this year, there was an equal and opposite boost in TAIL. That's because TAIL is specifically designed to protect against significant drops in the S&P 500—so-called tail-risk situations (read: "Journal Of Indexes: Tails, You Lose.")

To do this, TAIL uses an actively managed options strategy. Generally, the ETF holds mostly cash and Treasuries in its portfolio, but each month, it invests 1% of its holdings in out-of-the-money put options on the S&P 500 Index. (An out-of-the-money put option is a contract with a strike price that's lower than the market price of the underlying asset.)

If the S&P 500 Index falls below the options' strike price, TAIL's options allocation makes a nice chunk of change. If not, however, the options expire, making them worthless.

It's a strategy that obviously works better in down markets than up ones, and stock market plunges—like the one we've seen this December—are precisely where TAIL shines. Over the past month, for example, TAIL is up 15%; over the past three months, the ETF has risen 24%.

High Costs For TAIL

TAIL charges 0.59% annually—a price tag that might sound high at first, but that is actually 0.36% cheaper than the average target-outcome ETF.

Yet TAIL is a small and thinly traded ETF, with only $656K in shares traded daily on average. In addition, its average spread of 0.47% is on the high side, both for target-outcome ETFs and ETFs as a whole.

As a market-hedging instrument, TAIL has its advantages, but investors should trade this ETF with care.

Contact Lara Crigger at [email protected]

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