VEGA: July 2019 Portfolio Manager Review
Performance data quoted represents past performance and is no guarantee of future results. Current performance may be lower or higher than the performance data quoted. Investment return and principal value will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than original cost. Returns less than one year are not annualized. For the fund’s most recent standardized and month-end performance, please click www.advisorshares.com/fund/vega.
|MSCI ACWI World Index||0.29%||16.57%|
|Cboe S&P 500 Buy Write Index (BXM)||1.06%||11.43%|
|Bloomberg Barclays U.S. Aggregate Bond Index (AGG)||0.22%||6.35%|
As of 07.31.2019.
July looked like a continuation of June’s rebound off of May’s lows for the first part of the month. However, as July progressed into the dog days of summer, the market started to tumble around July 29th, losing significant gains. The S&P 500 for July, which broadly represents the U.S. markets was only up 1.44%, which seemed lackluster considering at it’s height, July was up over 3%. Fixed income had a moderate month, barely contributing to the over all returns.
The best place to be invested during the month of July would have been in the Technology and Consumer Discretionary Staples.
|Security||Ticker||July Total Return %|
|SPDR Select Sector Fund – Technology||XLK||3.50%|
|SPDR Select Sector Fund – Consumer Staples||XLP||2.34%|
The biggest laggards in July for the VEGA ETF were the health care sector and overseas mid- and large-cap developed markets.
|Security||Ticker||July Total Return %|
|SPDR Select Sector Fund – Health Care||XLV||-1.62%|
|iShares MSCI EAFE Index Fund||EFA||-1.95%|
|Ticker||Security Description||Portfolio Weight %|
|SPY||SPDR S&P 500 ETF TRUST||43.27%|
|[cash]||BLACKROCK LIQUIDITY T 60||11.91%|
|EFA||ISHARES MSCI EAFE ETF||9.32%|
|IGSB||ISHARES SHORT-TERM CORPORATE||5.58%|
|XLK||TECHNOLOGY SELECT SECTOR SPDR FUND||3.88%|
|BKLN||INVESCO SENIOR LOAN ETF||3.69%|
|XLY||CONSUMER DISCRETIONARY SELT||3.66%|
|XLP||CONSUMER STAPLES SELECT SECTOR SPDR FUND||3.66%|
|LMBS||FIRST TRUST LOW DURATION OPP||3.65%|
|HYGH||ISHARES INT RATE HEDG HY ETF||3.64%|
As of 07.31.2019.
Coming off the heels of June’s strong rally, the Covered Calls established at the end of June near expiration were both moderate coverage, approximately 50%, the range being between 25%-75% and low delta, about 0.25 versus a normal 0.30. This was done to allow VEGA to benefit from continued price appreciation of the post-May sell-off rally. When expiration hit around the middle of July, the SPY $303 Calls and EFA $67 Calls were near the money, but not In-the-Money. What that effectively means, is when we had established the Covered Calls in June, we had done an adequate job of selecting strikes to which the market would achieve, but not necessarily exceed. The July expiration calls were allowed to expire worthless. New Covered Calls on SPY & EFA were established with strikes of $305 and $66.50, respectively. These were also established with approximately 50% coverage, similar to June’s coverage, which is in the middle of our covered call coverage range of 25%-75% of the underlying. Additionally, the delta at the time these calls were establishment was 0.34 for SPY and 0.29 for EFA. This is up from June, as the rally which started in June seemed to have started to lose steam and the opportunity for significant price appreciation had diminished. Selecting a higher delta strike, allowed for high premium collection.
Going into July, the VEGA portfolio already held Protective Puts with an expiration of December 2019 and a strike price of $230, which at the time of establishment, were approximately 20% out-of-the-money. These were the same Protective Puts that were on in May and June, as well. Given the VIX was mostly stable during July, there was no opportunity to tactically dispose of the Protective Puts. Additionally, the percentage difference between the current Out-of-the-Moneyness and the Out-of-the-Moneyness at the onset of the position was deemed negligible and did not merit a trade to adjust to a new strike given the change in the underlying. As a result, no trades were completed on the Protective Puts in July 2019. Lastly, the percentage of the portfolio covered by Protective Puts was just above 20.79% versus the target of 20%.
At the start of July, the 200-day moving average of the VIX was 17.24. Having recently completed a Volatility-Based Reinvestment on May 9th, 2019, the established threshold for the next reinvestment was a VIX of 25.86 or 50% above the VIX 200-day moving average. During July 2019, the VIX opened at 13.85, hitting a high of 16.55 intramonth and closed at 16.12. Since the threshold was not breached during the month, no action was taken on the Volatility-Reinvestment Cash.
VEGA did not place any tactical shift or rebalancing trades during July. Both SPY and EFA remained on target at 43% and 9.50%, respectively. There are no immediate plans to either rebalance or tactically trade the underlying portion of the VEGA portfolio.
At expiration, the beta of the VEGA portfolio was approximately 0.63 to the S&P 500, inclusive of underlying holdings, as well as, all established option positions. This is in proximity to our target beta of 0.60. Although the July rebound was incorporated into the coverage of the options, after the return of extended volatility in Fourth Quarter 2019, it was deemed prudent to maintain a close-to-target beta, in the event that volatility returns.
Fixed Income continues to maintain a low-to-moderate duration portfolio. At the close of July, VEGA’s duration was 3.89. Given that the reversal from a rising rate environment to a decreasing rate environment was unexpected, VEGA was prepared for a continued rising rate environment. During July, no adjustments were made to VEGA’s duration, however, it may be adjusted after the Fed’s new dovish stance is reviewed in depth.
Partnervest’s Investment Management Committee has begun reevaluating all aspects of the market in order to recalibrate our market expectations for the remainder of 2019 and get a better perspective of the near- and intermediate-term moves. This reevaluation was catalyzed by the Fed moving the U.S. from a rising rate environment to a rate cutting environment, aggravated U.S.-China relations and May’s tumultuous markets. Here are some of our thoughts that will feed into our updated analysis.
U.S. Consumer – Still Strong, Best is Behind Us
- US. consumers are expected to contribute 1.5% (solid) of GDP growth, chugging along at a 2%-ish spending clip.
- We see nothing on the horizon related to the consumer that would force the Fed’s hand one way or the other.
- From the consumer standpoint, it is difficult to paint a recessionary picture for the next 6-12 months.
- Debt capacity/access to debt is still generally positive.
Political Landscape – Gridlock with Caution, But Could Get Worse
- The House has passed bills related to:
- Lower prescription drug prices
- Protection of pre-existing conditions
- Veterans’ issues (nine bills)
- Environmental issues (four bills)
- Military and foreign affairs issues (five bills)
However, popular belief is that they are all DOA when they reach the Senate, let alone getting to the President’s desk.
- The new budget deal sets spending beyond the 2020 elections (presumably to make both parties look “good”), while budget deficit and debt ceiling warnings have proven to be completely ignored.
- USCMA (formerly NAFTFA) vote is expected in Fall 2019.
- “I’m optimistic that we have a very good chance of getting that through.” Larry Kudlow (Source: CNBC)
- Both Democrats and Republicans acknowledge that meetings have been “open, constructive and successful” (Source: CNBC)
- Trade talks have restarted between the U.S. and China.
- Chinese economy has slowed to 6.2%, its weakest rate in 27 years.
- The cumulative negative impact on global annual growth rate due to tariffs on China is expected to be approximately 1.5% (Source: IMF, Bloomberg)
- Infrastructure investment is not likely to happen according to White House Chief of Staff Mick Mulvaney. Republicans and Democrats are most likely to work on:
- Raising the debt ceiling (completed as of 7/23/19)
- Passing a budget
- Getting USCMA trade agreement approved
- Information Technology is experiencing a showdown of power: Washington vs. Silicon Valley.
- Facebook was recently fined $5B by the FTC for violating promises Facebook had made to improve their privacy practices.
- Facebook’s LIBRA and regulation thereof has come under scrutiny by the government due to proposed implementation.
- Peter Thiel and others have accused Google of censoring Conservatives.
Earnings – Second Quarter Not as Bad as Originally Expected (So Far)
- …But earnings are still weak at-2.6% blended EPS growth YoY. (Source: FactSet)
- 2019 shows low-single digit YoY growth. (Source: FactSet)
- Sales are up 4%. (Source: FactSet)
- Merger and Acquisition activity is expected to be stable or accelerate during the 2nd half of the year.
- Banks who have reported earnings (Goldman Sachs, Citi, and Morgan Stanley):
- State that their clients have spent most of the year sitting on the sidelines.
- Are basing their earnings and economic guidance on the expectation of 1 – 3 rate cuts for the rest of 2019.
- There is general consensus that earnings growth is slowing, but not dying.
- Fastenal Company illustrates an example of slowing earnings growth:
- The company is eating half of the supply chain cost pass-thrus.
- Fastenal experienced their first sub-10% growth in the past nine quarters. An increase in tariffs means inflation.
- Customers are slower in paying.
- Inventory is too big; Fastenal stockpiled inventory prior to tariffs being implemented and now can’t get rid of it.
- Corporate management teams don’t want to take action on labor, capital expenditures, or wages.
- Anyone sourcing from off-shore is hurting—overseas weakness is showing up in corporate profits and is impacting managements’ decision making.
- It doesn’t appear that earnings will reach the high single digits number many had expected for 2019.
U.S. Federal Reserve – Don’t Fight the Fed, Because the Fed Isn’t Fighting Other “Feds”
- During the July 30-31 meetings, the Federal Reserved decided to cut interest rates by 25 basis points.
- We believe there will be one more rate cut, possibly two, this year (25bps each).
- However, the Fed’s choice to cut rates is confounding many other asset managers (including us) as to the rationale.
- One possible answer might be that the Fed doesn’t want to fight other central banks who appear to be committed to easing rather than further tightening.
- The Fed announced in March 2019 its desire to end its balance sheet runoff program in September 2019, yet at the July 30-31 meeting, decided to cease the program early.
Real Estate – How Much are Lower Rates Helping?
- Neutral to modestly positive outlook; this area won’t be a huge driver of the economy but contributes to overall growth. Prices are high across the board but have been higher in past cycles.
- Housing starts could remain flat/stable YoY with potential surprise to the upside.
- S. existing home sales growth rate fell in 2018, but has rebounded nicely thus far in 2019.
- The U.S. 30-year mortgage rates started the year at 4.51%, but have since fallen to 3.75% (as of 7/25/2019).
- Despite falling mortgage rates, existing home sales fell in June for the 16th month in a row.
- In the monthly press release, Lawrence Yun, the National Association of Realtors chief economist noted, “Home sales are running at a pace similar to 2015 levels – even with exceptionally low mortgage rates, a record number of jobs and a record high net worth in the country… Imbalance persists for mid-to-lower priced homes with solid demand and insufficient supply, which is consequently pushing up home prices… Either a strong pent-up demand will show in the upcoming months, or there is a lack of confidence that is keeping buyers from this major expenditure. It’s too soon to know how much of a pullback is related to the reduction in the homeowner tax incentive.”
- At a briefing in Washington, Yun also commented “Sales refuse to break out higher” noting “it doesn’t make economic sense” given the backdrop of job creation, rising wages, and strong equity market returns.
- Housing starts showed unwanted inventory at the end of 2018 but have since rebounded in 2019 (low rates also helped). Overall, housing starts could end up flat to slightly positive for FY 2019
- Home prices show a much more negative price outlook from higher income household; different than in the past.
- Mortgage originations picked up with the bulk of these seeming to be refinance driven. There has been growth from young adult population growth (some states are winners and some are losers). Stable to possibly mild improvement going to the end of the year.
Sources: National Association of Realtors (NAR), US Census Bureau
Europe – Muddling Along as Usual, No Change in Outlook
- We anticipate a rate cut (sending benchmark rates even more negative) this year, possibly this quarter.
- Europe is muddling along, but the changing of leadership (LaGarde replacing Draghi at the ECB, Boris Johnson as the new UK PM) may provide an opportunity for stronger growth and higher equity prices.
- European countries (e.g., Germany, Italy) are experiencing weak GDP growth that is overall half of U.S. GDP growth (e.g., U.S. approximately 2%, Germany approximately 1%).
- Most countries have negative rates except for Greece.
- Interest rate spread between US and Europe is 2%+.
- The U.S. dollar has strengthened 4% over other currencies, which corresponds with the U.S. having higher GDP and higher interest rates.
- Through July 29, U.S. markets are up approximately 21% YTD and Europe is up 14-15% YTD (Source: YCharts). All of this is a bounce-back from the misery of Q4 2018.
- Monetary policy – The European Central Bank (ECB) monetary policy has included buying sovereign bonds and is putting pressure on corporate bonds. This leaves equities as the remaining option for growth.
- The European banking sector may be in trouble and could lose a name or two in the next 12 months (e.g., Deutsche Bank).
- Banks appear to be stuck in a rut of super low growth.
- June showed disappointing (Flash) PMIs across the board (IHS Markit):
- Germany Manufacturing PMI falls to 43.1, an 84-month low
- Eurozone Manufacturing PMI falls to 46.4, a 79-month low
- Composite PMIs in Germany, France, and the broader Eurozone all fell MoM and YoY into the low(er) 50s, indicating very tepid growth.
No Change in View, still unclear as to the directionality of key players
Partnervest had planned for increased volatility during 2019 and maintains good posture in our VEGA strategy for any continued volatility. Entering the market reevaluation exercise, the Investment Team remains generally cautious with an eye towards holding onto strong YTD gains. After robust discussion, we have decided not to make any changes to the current strategy allocations at this time. The decision-making process regarding the VEGA strategy allocations is fluid and we will notify you of changes in our thinking.
We appreciate your continued conviction in Partnervest and our investment team.
Very Truly Yours,
Partnervest Advisory Services, CIO
AdvisorShares STAR Global Buy-Write ETF (VEGA), Portfolio Manager
Past Manager Commentary
Information is from sources deemed to be reliable, but accuracy is not guaranteed.
*Performance and pricing data used for VEGA ETF is based on the indicated value of the ETF at the close of the day.
The Barclays Capital U.S. Intermediate Government Bond Index measures the performance of U.S. Dollar denominated investment grade U.S. corporate securities that have a remaining maturity of greater than one year and less than ten years.
The Cboe S&P 500 BuyWrite Index (BXM) is a benchmark index designed to track the performance of a hypothetical buy-write strategy on the S&P 500 Index.
The MSCI ACWI World Index is is an unmanaged free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets.
An option is a privilege, sold by one party to another that gives the buyer the right, but not the obligation, to buy (call) or sell (put) a stock at an agreed upon price within a certain period or on a specific date.
An option premium is income received by an investor who sells or “writes” an option contract to another party.
A covered call option involves holding a long position in a particular asset, in this case shares of an ETP, and writing a call option on that same asset with the goal of realizing additional income from the option premium.
A put option is a contract that gives the owner of the option the right to sell a specified amount of the asset underlying the option at a specified price within a specified time.
A protective put is an option strategy which entails buys shares of a security and, at the same time, enough put options to cover those shares. This can act as a hedge on the invested security, since matching puts with shares of the stock can limit the downside (due to the nature of puts).
Exercising an option means to put into effect the right specified in a contract.
The Purchasing Managers’ Index (PMI) is an indicator of the economic health of the manufacturing sector. The PMI is based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment.
Before investing you should carefully consider the Fund’s investment objectives, risks, charges and expenses. This and other information is in the prospectus, a copy of which may be obtained by visiting www.advisorshares.com. Please read the prospectus carefully before you invest. Foreside Fund Services, LLC, distributor.
There is no guarantee that the Fund will achieve its investment objective. An investment in the Fund is subject to risk, including the possible loss of principal amount invested. Other Fund risks included: allocation risk; derivative risk; early closing risk; Exchange Traded Note risk; liquidity risk, market risk; trading risk; commodity risk; concentration risk; counterparty risk; credit risk; emerging markets and foreign securities risk; foreign currency risk; large-, mid- and small- cap stock risk. Please see the prospectus for detailed information regarding risk. The Fund is also subject to options risk. Writing and purchasing call and put options are specialized activities and entail greater than ordinary investment risk. The value of the Fund’s positions in options fluctuates in response to the changes in value of the underlying security. The Fund also risks losing all or part of the cash paid for purchasing call and put options. The Fund may not be suitable for all investors.
Shares are bought and sold at market price (closing price) not NAV and are not individually redeemed from the Fund. Market price returns are based on the midpoint of the bid/ask spread at 4:00 pm Eastern Time (when NAV is normally determined), and do not represent the return you would receive if you traded at other times. Holdings and allocations are subject to risks and to change. The views in this commentary are those of the portfolio manager and may not reflect his views on the date this material is distributed or anytime thereafter.
The views in this material were those of the Portfolio Manager and may not reflect his views on the date this material is distributed or anytime thereafter. These views are intended to assist shareholders in understanding their investments and do not constitute investment advice.