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Risk-On/Risk-Off Trade — In Fund Form, Entirely Unnecessary

Exchange-traded ONN, OFF have a number of issues


Forget spring break — the real party these days is being held in the offices of exchange-traded product providers. The latest installment of “Product Developers Gone Wild” brings us two interesting, but entirely unnecessary, exchange-traded portfolios: the ETRACS Fisher-Gartman Risk On ETN (NYSE:ONN) and its counterpart, the ETRACS Fisher-Gartman Risk Off ETN (NYSE:OFF).

Launched on Nov. 29, these two ETNs are designed to provide investors with a way to capitalize on the greed-fear cycle. And so far they’re performing as intended: Since inception, ONN has gained 10.18%, while OFF has slipped -12.10%. Both are trading within pennies of their net asset values, indicating that they aren’t in jeopardy of the meltdowns suffered by other ETNs in recent weeks.

Nevertheless, three issues are immediately apparent.

First, there really is no need for investors to own these products when there are any number of options to play the risk-on/risk-off trade. Someone who is looking to express a view on this front can buy any number of stocks, bonds or currencies that will provide the same type of exposure. What’s more, many such instruments can provide much higher beta on the risk trade than either ONN or OFF. Why not simply make a play on the iShares MSCI Emerging Markets Index ETF (NYSE:EEM) to achieve higher beta exposure with a lower expense ratio? (EEM charges 0.67% per year, while ONN charges 0.85% and OFF’s expense ratio is 1.15%.)

Second, these ETFs assume the “risk-on/risk-off” market that has characterized the past three to four years will continue. This two-way market is a relatively new phenomenon brought about by the constant series of crises and central bank-induced recoveries. Assuming the world one day returns to an environment of normalized business cycles, these ETNs will be even less useful as of a source of beta.

Third, and most important, is the fact that 34% of ONN is allocated to oil futures, while OFF has a short position amounting to -34% of assets. (See below for the full allocations.) While it’s reasonable to expect that oil will trade with a positive correlation to investor risk appetites, this relationship will be turned on its head if there is any turmoil in Iran. Disruptions in the Middle East could cause the price of oil to soar even as other segments of the financial markets would go into risk-off mode. In this case, the funds would fail to track the risk environment as intended. It’s not the most likely scenario, to be sure, but if OFF can’t effectively hedge one of the largest sources of tail risk in the market, what purpose does it serve?

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For now, these investments might be worth keeping an eye on to gain a sense of the collective performance of higher-risk assets. In recent weeks, the rising fear about China’s economy and the coming earnings season can be seen in the moderating performance of ONN:

Otherwise, these two funds might sound compelling from a marketing standpoint, but they have little practical application for investors.

How Are the Funds Allocated?

ONN is 150% long and 50% short in investments that would be expected to underperform when risk appetites are high, while OFF is allocated in the opposite manner.

Risk-On Long Short Risk-Off Long Short
Energy 48% 0% Energy 0% -48%
Equities 46% 0% Equities 0% -46%
Currencies 28% -16% Currencies 16% -28%
Sovereign Bonds 0% -34% Sovereign Bonds 34% 0%
Agriculture 18% 0% Agriculture 0% -18%
Metals 10% 0% Metals 0% -10%

The holdings of the risk-on portfolio are as follows (the risk-off fund is simply the inverse):

Risk-On Longs Weighting Risk-On Shorts Weighting
Crude Oil 20% 10-Year U.S. T-Note -16%
Brent Oil 14% Yen -12%
Euro 14% German Bund -12%
Corn 10% 10-Year U.K. Gilt -6%
SPDR S&P 500 ETF (SPY) 9.2% Swiss Franc -4%
Australian Dollar 8%
Heating Oil 6%
Copper 6%
Canadian Dollar 6%
iShares MSCI Hong Kong
PowerShares QQQ 5.52%
Unleaded Gasoline 4%
Gas Oil Subindex 4%
Wheat 4%
Soybeans 4%
Silver 4%
SPDR Dow Jones Industrial
Average ETF (DIA)
iShares S&P 500 Index
Fund (IVV)
Rydex S&P Equal Weight
iShares MSCI Brazil Index
Fund (EWZ)
Fund (FEZ)
Select Sector Technology
Vanguard Large-Cap ETF
iShares MSCI EAFE Index
Fund (EFA)
Vanguard MSCI European
WisdomTree Dreyfus Brazilian
Real Fund (BZF)
Guggenheim BRIC ETF (EEB) 0.46%
First Trust Dow Jones Internet
Index Fund (FDN)
Market Vectors Russia ETF (RSX) 0.46%
Schwab U.S. Large-Cap ETF

As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media,

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