“Most years, this fund will lose money.”
That’s an unusual way to start a conversation about a new exchange-traded fund, but Meb Faber, Cambria Investment’s founder and chief investment officer, wants to make sure investors use the Cambria Tail Risk ETF (TAIL) for its stated purpose. Namely, to provide portfolio insurance against significant downside market risk.
The fund deploys a small percentage of its assets in “out-of-the-money” S&P 500 put options, with expiration dates in the three- to 15-month range. Most of the fund is invested in intermediate-term U.S. Treasuries.
There are a broad range of exchange-traded products that aim to hedge against market downdrafts, including the myriad inverse funds and VIX-focused volatility funds. But Faber believes they’re flawed, and opines that they can be very complicated and complex for most investors to understand, or are simply too expensive.
The ProShares UltraShort S&P500 (SDS), for example, is the largest ETF in the bear market category with $1.5 billion in assets, and it comes with a lofty 0.90 percent expense ratio. The iPath S&P 500 VIX Short-Term Futures ETN (VXX), the largest product among VIX-related ETPs, sports a similar 0.89 percent expense ratio.
The Cambria Long Tail Risk ETF, in contrast, has a 0.59 percent expense ratio. The fund has only been trading since April 6, explaining its still-small $2.5 million asset base.
This week’s market rally following the first round of the French presidential election, combined with solid corporate earnings reports, has added to investor complacency, as witnessed by the CBOE Volatility Index siting under 11 as of Wednesday’s market close. That's well below the four spikes into the 20 to 25 range experienced since July 2015, and far below the reading of 79 seen at the height of the 2008 market slump.
The current low levels of volatility make this put-buying approach appealing to investors who have a bearish view of the markets. That's because the cost of such insurance is very low right now, although S&P put options would become much more expensive once volatility finally moves higher. That suggests you would not want to buy shares of this ETF once volatility has spiked.
As Faber says, “this strategy is not a good long-term investment.” He likens it to insurance, a cost burden that brings peace of mind.
But because equities are up more than they’re down historically, the likely negative long-term returns of TAIL brings with it a completely different opportunity. “Over long periods, shorting this fund would be profitable,” says Faber.