The Economic Roots Of Beta Climates

May 30, 2009

How independence can tell you if the beta climate is too hot, too cold or comfortable.

Model Portfolio: The Arrow Insight (AI) 75-50 Portfolio

Long/Short Exchange Traded Funds (ETFs) & Closed End Funds (CEFs)

AI's Axiom: "Capturing desired source returns while avoiding unwanted beta and limiting default risk."

Primary Objective: 75% of the market's (S&P 500 Index) positive and 50% of its negative returns over 12-month periods. This profile drives the model's strategic allocation and tactical trades.

Secondary Objective: The portfolio satisfies a need to employ a capital originally allocated to hedge funds into a proxy but without their baggage (excessive fees, limited transparency, illiquidity, and high business risk). Consequently, AI 75/50 has an absolute return objective consistent with meeting our primary objective over 36-month rolling time-periods.

Summary Objectives: AI 75/50 first seeks capital appreciation while attempting to provide positive returns over all 36-month time horizons since the portfolio's inception date on March 19, 2004. The portfolio also attempts to best the returns of the S&P 500 Index (S&P) and The Hedge Fund Research (HFR) Investable Global Index (HFRX) during these periods.

Recent Returns: Month-to-date (MTD) we are up 9.1% through May 21. Year-to-date (YTD) we are up 17.7%.

Returns for the last three calendar years were -2.2% in 2008, 8.8% in 2007 and 18.3% in 2006.

Since the portfolio's inception, the cumulative return has been 68% (Figure 4).

Recent Trades, Current Positions, Indexes & Asset Classes

Since our last InFocus on April 24, all trades have been defensive. We will cover the rare employment of put options first (Table 1). On May 12, we purchased 10 long July 875 puts on the S&P 500 (SPX) at $35 (SPXSO). At the time of purchase, SPXSO represented 3% of our 146% in gross exposures. On May 19, we established a sell limit order at $19.50 on 5 contracts (Figure 1). We were taken out of our 5 contracts at $19.90 early in morning the next day, which was May 20, an outside-reversal day (Figure 7). Although sell limit orders control losses, we sold at SPXSO's at the low of the day. We were left with 5 contracts valued at $46.40 at the May 21 close.

To compensate for the losses on the contracts sold and to limit out opportunity costs, we canceled orders to sell half of SPXSO at $55 and half at $70 and entered an order to sell the remaining 5 contracts at $80. We also added 3% (1.5% before leverage) more exposure to the UltraShort Consumer Services ProShares Fund (SCC) on May 21. Investors often get taken out of their best defense on outside-reversal days. Since these days are a bearish indicator, option investors need to reestablish defense soon after they lose their positions. We chose not to rebid the 5 contracts sold.

Table 1. Option Trades


Group Symbol Date and Time Operation Instrument/
Quantity Price Total Commission
Common SPXSO 5/12/09 Buy Option Put 10 35 35000 8.95
Common SPXSO 5/20/09 Sell Option Put 5 19.9 9950 8.95

Figure 1. SPXSO Strategy



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