Finding The Perfect Hedging Tool: Can It Be Done?

We have always been believers in the idea that a proper hedge is essential to the creation of a well-rounded equity portfolio. However, there is a severe lack of proper hedging instruments available in the market. Volatility products are useful only as short-term trading instruments; they are unusable as long-term hedges. Most short funds are either leveraged and/or have daily resetting mechanisms, which means that they too are suitable only as short-term trading instruments. And while we own gold, its usefulness as an equity hedge is not fully clear. It is important for investors to remember that gold does not move inversely to the S&P 500 100% of the time; gold and equities often rise and fall in tandem, which is not a desirable quality in a long-term hedge (this statement should not be construed as us being bearish on gold; but rather a recognition of the fact that the performance of gold is not necessarily driven by weakness in equity markets). Over the past several months, we have been searching for a proper long-term hedge. For some time, we have held the Ranger Equity Bear ETF (HDGE), but its performance has been underwhelming over the past 6 months relative to the S&P 500. And with its expense ratio no longer capped, the full cost of actively shorting the select stocks is now passed to the fund's investors. With annual expenses of 3.3%, we no longer believe in the fund's usefulness as a long-term hedging tool, at least for the time being. However, when one door closes, another one opens. And this door has led us to the ETRACS Fisher-Gartman Risk Off ETN (OFF).

This ETN, marketed by UBS, is an interesting product, blending together many of the aspects that we look for in a hedge. As its name implies, this ETN is long "risk off" assets, such as Treasuries, the Swiss franc, and German bunds. But what makes it more interesting is that this long exposure to "risk off" assets is paired with short exposure to a variety of "risk on" assets, including commodities and emerging market stocks. This exposure mix produces what we believe is a solid long-term hedging instrument. Since inception (December 2011), this ETN has lost over 17% of its value as of this writing, versus a gain of 22% for the S&P 500, meaning that it has outperformed relative to the market. And its chart since inception is a near mirror image of the S&P 500. This ETN is unleveraged, has no daily reset, and with an expense ratio of 1.15% it is inexpensive relative to its holding benefits. We have been buying shares of OFF over the past several weeks, and believe that investors looking for a long-term hedge against their equity exposure should do the same.