Ongoing Market Uncertainty
Market volatility can strike quickly and unexpectedly. History tells us that increased market fear and uncertainty typically correspond with declines in the broader market.
How to Hedge Against Market Uncertainty?
Investors can gain exposure to the fluctuations in volatility through VIX futures. Historically the correlation of VIX futures to the S&P 500® Index has been no higher than -0.75. In other words, when the S&P 500 has performed poorly, VIX futures have generally performed well. The cost of holding a constant allocation of VIX futures, however, can be significant. Ongoing roll costs can drag portfolio returns.
Rules-Based Management of VIX Futures
Dynamically allocating to VIX futures through a rules-based strategy may help mitigate roll costs while still providing a hedge against downside losses. In addition, this strategy has the potential to generate a positive return in negative equity markets.
S&P 500 Dynamic VEQTOR Index vs S&P 500 Index
Sources: Standard & Poor's and Bloomberg L.P. from Nov. 18, 2009 through Dec. 31, 2012
The idea behind PowerShares S&P 500 Downside Hedged Portfolio is simple – dynamically allocate to VIX futures depending on historical and forward-looking market volatility trends.
According to the strategy allocation rules as defined by the underlying index, the S&P 500® Dynamic VEQTOR Index (the Index), when market uncertainty rises, the fund will add to its market hedge through VIX futures. In a falling equity market, increasing allocations to VIX futures may not only hedge downside losses, but may allow for positive strategy performance in down markets. As market uncertainty falls, the fund will decrease the amount of its market hedge. Given the uncertainty in the markets, the fund is designed to maintain a degree of downside hedging via VIX futures or cash regardless of the market environment.
Lastly, the index has a built-in stop loss mechanism which seeks to allow the Fund to move to 100% cash if losses over the preceding five-day period are greater than 2%. This stop loss feature can serve as a circuit breaker to help minimize significant losses due to a sudden spike in volatility and an abrupt drop in the equity market.
Under normal circumstances the Fund maintains a minimum 2.5% exposure to VIX futures. As market uncertainty rises, the Fund can allocate as much as 40% of the portfolio to VIX futures.
Increasing Your Hedge As Market Uncertainty Rises
FOR ILLUSTRATIVE PURPOSES ONLY; Market uncertainty is defined as a combination of both historical and implied volatility.
The PowerShares S&P 500 Downside Hedged Portfolio is an actively managed exchange-traded fund (ETF) that seeks to achieve positive total returns in rising or falling markets that are not directly correlated to broad equity or fixed income market returns.
About the Fund
- Employs a quantitative, rules-based index strategy designed to provide returns corresponding to the performance of the S&P 500 Dynamic VEQTOR Index
- Seeks to provide low correlation to the broader equity and fixed-income markets
- Will invest in a combination of equity securities in the S&P 500 Index, VIX futures contracts and cash
- Through the rules-based index it tracks, Fund allocations are determined by analysis of historical and implied market volatility as well as Fund performance
- Evaluated on a daily basis
- No K-1, issues 1099
- 0.39% total expense ratio
About the Index
The S&P 500 Dynamic VEQTOR Index provides investors with broad equity market exposure with an implied volatility hedge by dynamically allocating between equity, volatility and cash. The index allows investors to receive exposure to the equity and volatility of the S&P 500 Index in a dynamic framework.