“The stock market is far more likely to blow up…than your house is likely to burn down.”
– Active Bear ETF manager John Del Vecchio
A lot of investors have been feeling bearish lately after the stock market’s red-hot run since Thanksgiving. After all, expensive oil, high unemployment, persistent housing trouble and more provide good reasons to doubt the rally.
If you’re in the bearish camp, or even if you’re just an investor who likes to hedge your bets, it’s worth noting that there are a number of investments that can help you play the downside of stocks.
I’m not talking about buying puts or short-selling on margin. I’m talking about the most mundane of all investments to profit from a fall in the market: an actively managed ETF.
It sounds odd, but the AdvisorShares Active Bear ETF (NYSE:HDGE) has a strategy that aligns perfectly with the name of the fund. It’s an active fund managed by human beings, not pegged to an index, which seeks out bearish investments that can deliver gains to investors as underlying assets fall.
It’s an intriguing concept — not just for those looking to profit from a crash but also for folks looking for a kind of “insurance” policy for their portfolio. As the ticker symbol implies, a little bearish investing can do a great deal of good for investors simply looking to hedge their bets.
I caught up with Active Bear ETF manager John Del Vecchio this week and asked him how he operates the fund, how investors can use it and what makes him feel decidedly bearish about the current environment.
Q: Your active management style sets this ETF apart from conventional “inverse ETFs.” Can you explain the difference?
A: We focus on individual stocks that we believe have risk of missing earnings or reduced guidance primarily because management is acting aggressively with its accounting. In addition, we determine our exposure based on our view of the market with respect to how overbought or oversold it is, valuation, and whether investor sentiment is at extremes. This allows us to build a portfolio of securities that we think over time will work well on the short side. As our opinions change on stocks or the market, so will the composition of the portfolio.
An inverse fund is linked to an index, such as the S&P 500. Also, some of them are levered. We do not use leverage, nor are we linked to an index. We feel we have an advantage because if the S&P 500 does experience a correction, it will be driven by companies such as Apple (NASDAQ:AAPL), Google (NASDAQ:GOOG), Johnson & Johnson (NYSE:JNJ), General Mills (NYSE:GIS), etc., which make up a large portion of the index. Do you really want to short Apple, which is a market leader, or Johnson & Johnson, which has a huge dividend?
Neither do we.
Q: The Active Bear prospectus says the fund selects short positions in securities with low earnings quality or aggressive accounting intended to mask operational deterioration. Do you think that strategy is easier or harder than picking “good” stocks?
A: Nothing is “easy” in the stock market. But our process has been in use and refined over 13 years. I think my view of the world is that I like to catch people with their “hand in the cookie jar.” I’m wired to enjoy finding a stock that goes down 30% because management overstated revenues [rather] than try to find the next big winner that goes up 300%. In addition, most stocks are losers over time. What happened to Kodak, Polaroid, General Motors (NYSE:GM), Bethlehem Steel, all of which were huge companies in the 1970s? They’re all dead money. The same thing happened with the big Internet stocks. They haven’t done much for over a decade.