23/3/2016 ConsiderUltraLowVolatilityInvestingPartVIII|SeekingAlpha

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ConsiderUltraLowVolatilityInvestingPartVIII
Mar.22,20168:27AMET5comments
by:HarryLong

Summary
TheUltraLowVolatilityIndexhasbeenoneofourgreatestsuccesses.

Theindexiselegantlysimple,yetpowerful.

Theindexissolid,notglamorous.

Theindexcanmakeaportfoliofarsafer.

HerearetheUltraLowVolatilityIndex'srules.

1.BuythePowerSharesS&P500LowVolatilityPortfolioETF(SPLV)with80%ofthedollarvalueoftheportfolio.

2.BuytheDirexionDaily30YearTreasuryBull3xSharesETF(TMF)with20%ofthedollarvalueoftheportfolio.

3.Rebalanceannuallytomaintainthe80%/20%dollarvaluesplitbetweenthepositions.

Thelogicbehindthestrategyisthat,duetothenatureofcompoundinggainsandlosses,astrategywhichhasextremelylow
volatilityhasthepossibilitytobeatingthemarketacrossanentirebull/bearcycle.

Forexample,a50%drawdownnecessitatea100%recoveryinaportfoliotobreakeven.Wecanseethenonlinearnature
ofriskvs.return.

ConsiderthissummaryoftheissuebyZacks:

"Themathofpercentagesshowsthataslossesgetlarger,thereturnnecessarytorecovertobreakevenincreasesatamuch
fasterrate.Alossof10percentnecessitatesan11percentgaintorecover.Increasethatlossto25percentandittakesa33
percentgaintogetbacktobreakeven.A50percentlossrequiresa100percentgaintorecoverandan80percentloss
necessitates500percentingainstogetbacktowheretheinvestmentvaluestarted."

Therefore,thegoaloftheindexistonotgiveupmuchequityupsidebycombiningtheS&P500LowVolatilityETFwitha3x
leveragedexposuretolongdurationgovernmentbonds,whichactsasanimperfecthedge.

BecauseoftheleverageinherentinTMF,wecanallocatemorecapitaltoSPLV.Inaddition,itisnotnecessarytohave
marginexposure.Soinsteadofthenormalstock/bondmix,weareutilizingtheS&P500LowVolatilityETF,thencombining
thatwithleveragedlongdurationgovernmentbondexposure,inanefforttofurtherreducedrawdownsandvolatility.

Thepatternoftheindex'spastperformanceseemstobethatitoutperformsduringdownperiodsforU.S.equitiesand
underperformsthemarketduringstrongupperiods.

Ofcourse,aprolongedbearmarketinlongdurationgovernmentbondswouldprobablyhurtthisstrategyindex,butthetotal
bondexposureatriskisonly20%inanygivenyear,becausetheleveragednatureofTMFallowsustodedicatelesscapital
toit.

Today,Iwanttofocusonhowthisstrategyindexbehavesduringstockmarketdislocations.

2011isespeciallyinstructive:

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Whenthemarketsdroppedin2011,theindexactuallyhadaslightlynegativecorrelationtotheS&P500!TheMARratio
(CAGR/MaximumDrawdown)almosthit10.Thisisincrediblyimpressive.

Inaddition,thevolatilityleveloftheindexishalfofthatoftheSPY.

YTD,theresultsaresimilarlystunning:

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Personally,Ithinkmostinvestorswantaportfoliothatwilltreadwater,holditsown,andonlydropslightlywhenmarketsare
goingcrazy.Lowdrawdownsandultralowvolatilityenableaninvestortohangonandtoactuallyenjoythepossibilitiesof
thelongterm.Fortoolong,peoplehavehadthepaintheoryofinvestingpoundedintotheirhead.

Thepaintheoryofinvestingsoundsveryheroicandglamorous,butinreality,asmoothrideallowsinvestorstoholdonto
theirpositionsinordertoenjoythebenefitsofthelongterm.

Whygetshakenout,whenyoucanhaveasmootherride?Andthesmootherride,inthiscase,hasahigherreturnacrossa
fullbull/bearmarketcycle.

DuetothelimitedtradinghistoryofSPLV,let'strytoguesstimatewhatperformancemighthavebeenbyusingaclose
substituteforSPLV,theXLP(NYSEARCA:XLP)consumerstaplesETF:

http://seekingalpha.com/article/3960157considerultralowvolatilityinvestingpartviii?ifp=0&app=1 3/6
23/3/2016 ConsiderUltraLowVolatilityInvestingPartVIII|SeekingAlpha

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WeoutperformtheS&P500,whilehavinga0.22correlationtotheSPY(NYSEARCA:SPY)ETF,andcuttingthemax
drawdownalmostinhalf!Remember,wehavesubsitutedXLPforSPLVinordertoseemoredata.

Let'szeroinonApril16th2009totheendof2011usingXLP:

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Weagainseeoutperformance,amaxdrawdownthathasbeenmorethancutinhalf,adoubledSharpe,afarsuperiorMAR,
andalmostnocorrelationtotheS&P500.Trulyspectacular.

Andagain,thepatternthatinbigupperiodsforthestockmarket,theindexlags,andforbigdownperiodsforthestock
market,theindexoutperforms.Thisleadstooveralloutperformancesincemarketdropshurtinvestorsfarmorethanbigup
yearsforthemarkethelp.

Iwouldarguethattheinclusionofthisindexinmostpensionfundandendowmentfundportfolioswouldmakethemfarsafer
andmoreresilienttoequitymarketshocks.Thehistoricalevidencebearsthisout.

Hereiswhatinvestorscantakeawayfromthisindex:

I.Formaximumoverallperformancethroughamarketcycle,itisbettertoavoidbiglossesthantomakebiggains.

II.Inpractice,thisoftenmeansoutperforminginbearmarketsandlagginginbullmarkets.

III.Prudently,loweringthevolatilityofaportfoliocanhelp.

IV.Thebestwaytolowerthevolatilityofaportfolioisthroughexposuretomultipleassetclasses,balancedcorrectly.

Thanksforreading.Wefeatureevenmoreimpressivestrategyindicesinoursubscriptionservice.Ifthispostwasusefulto
you,considergivingitatry.

Hypotheticalperformanceresultshavemanyinherentlimitations,someofwhicharedescribedbelow.Norepresentationis
beingmadethatanyaccountwillorislikelytoachieveprofitsorlossessimilartothoseshowninfact,therearefrequently
sharpdifferencesbetweenhypotheticalperformanceresultsandtheactualresultssubsequentlyachievedbyanyparticular
tradingprogram.Oneofthelimitationsofhypotheticalperformanceresultsisthattheyaregenerallypreparedwiththe
benefitofhindsight.Inaddition,hypotheticaltradingdoesnotinvolvefinancialrisk,andnohypotheticaltradingrecordcan
completelyaccountfortheimpactoffinancialriskofactualtrading.Forexample,theabilitytowithstandlossesortoadhere
toaparticulartradingprograminspiteoftradinglossesarematerialpoints,whichcanalsoadverselyaffectactualtrading
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results.Therearenumerousotherfactorsrelatedtothemarketsingeneralortotheimplementationofanyspecifictrading
program,whichcannotbefullyaccountedforinthepreparationofhypotheticalperformanceresultsandallwhichcan
adverselyaffecttradingresults.

Disclosure:I/wehavenopositionsinanystocksmentioned,butmayinitiatealongpositioninSPYoverthenext72hours.

Iwrotethisarticlemyself,anditexpressesmyownopinions.Iamnotreceivingcompensationforit.Ihavenobusiness
relationshipwithanycompanywhosestockismentionedinthisarticle.

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