Barclays rolled out the latest addition to its line of ETNs, launching the S&P VEQTOR ETN (VQT). The new exchange-traded note will saddle the line between active and passive; it is linked to the S&P 500 Dynamic VEQTOR Total Return Index, a benchmark that provides broad equity market exposure with an implied volatility hedge by dynamically allocating its notional investments among three components: equity, volatility, and cash [see Free 7 Simple & Cheap All-ETF Portfolios].
The equity component of the underlying index is represented by the S&P 500 Total Return Index, while the volatility component consists of the S&P 500 VIX Short-Term Futures Index. The investment thesis behind the new ETN is this: equity market volatility tends to exhibit a negative correlation with performance of equity markets. So the underlying index will allocate a greater portion of its notional principal to equity markets (i.e., the S&P 500) during periods of low volatility and a greater portion to volatility futures during periods of high volatility.
In addition, the index maintains a “stop loss” mechanic that shifts the entirety of the index to cash under certain circumstances. That mechanism would kick in if the underlying index has lost 2% or more of its value over any five consecutive business day period [For updates on all new ETFs, sign up for the free ETFdb newsletter].
The allocation between volatility and equities will depend on both the realized volatility and the presence of a volatility trend.With realized volatility of less than 10% and no volatility trend, the allocation to equity can go as high as 97.5%. If realized volatility spikes to more than 45% and an implied volatility uptrend is present, the equity allocation will drop to 60%.
So VQT is essentially a combination of SPY and VXX–the ETN from iPath linked to an index consisting of short-term VIX futures–with the allocations to these two asset classes changing based on market conditions. The new ETN offers a way for investors to maintain broad exposure to U.S. equity markets while hedging against a downturn. VQT should exhibit lower volatility than SPY, trailing behind the S&P 500 SPDR during bull markets but delivering better returns when markets slump. That’s because the correlation between the volatility and equity components of the index is close to -1.0 [see Guide To Volatility ETNs].
VQT will charge an expense ratio of 0.95%.
Disclosure: No positions at time of writing.