VEGA: June 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||6.55%||16.23%|
|Cboe S&P 500 Buy Write Index (BXM)||5.06%||10.27%|
|Bloomberg Barclays U.S. Aggregate Bond Index (AGG)||1.26%||6.11%|
As of 06.30.2019.
June saw a reversal from the declines seen in May. Across the board, equities posted strong gains as markets recovered from the previous month’s losses. Fixed income participated in the rally as well with the Fed hinting future rate cuts and global markets heading towards negative rate environments. Overall, June was a strong month for the portfolio.
The best place to be invested during the month of June would have been in the Technology and Consumer Discretionary Sectors.
|Security||Ticker||June Total Return %|
|SPDR Select Sector Fund – Technology||XLK||8.94%|
|SPDR Select Sector Fund – Consumer Discretionary||XLY||7.82%|
The biggest laggards in June for the VEGA ETF were Senior Bank Loans and Short-Term Bonds.
|Security||Ticker||June Total Return %|
|Invesco Senior Loan ETF||BKLN||0.52%|
|First Trust Low Duration Opportunities ETF – Short-Term Bond||LMBS||0.58%|
|Ticker||Security Description||Portfolio Weight %|
|SPY||SPDR S&P 500 ETF TRUST||42.93%|
|[cash]||BLACKROCK LIQUIDITY T 60||11.81%|
|EFA||ISHARES MSCI EAFE ETF||9.57%|
|IGSB||ISHARES SHORT-TERM CORPORATE||5.62%|
|XLK||TECHNOLOGY SELECT SECTOR SPDR FUND||3.78%|
|BKLN||INVESCO SENIOR LOAN ETF||3.68%|
|LMBS||FIRST TRUST LOW DURATION OPP||3.67%|
|HYGH||ISHARES INT RATE HEDG HY ETF||3.67%|
|XLY||CONSUMER DISCRETIONARY SELT||3.64%|
|XLP||CONSUMER STAPLES SELECT SECTOR SPDR FUND||3.60%|
As of 06.30.2019.
After May’s poor performance for both the U.S. and Non-U.S. Equity Markets, both the Covered Calls for June on SPY (strike $293) and EFA (strike $66) were low in intrinsic value. Given the low cost to repurchase the Covered Calls, coupled with more than 2 weeks left until June expiration, the Covered Calls were purchased on SPY and EFA on June 3rd. On the same day, new calls were initiated with new strikes were established on SPY and EFA, $283 and $64.50, respectively. For this, a new round of premium was received during June. However, the poor performance in May and early June was shortly followed by a large upswing in both SPY and EFA. This resulted in the Covered Calls with strikes of $283 and $64.50 going into the money within a week of establishment. Given a week remaining until expiration, both Covered Calls on SPY and EFA were exited. The rebound being strong, all positions were left without Covered Calls during that period, to allow for additional price appreciation. After expiration on June 24, 2019, new Covered Calls were established on SPY and EFA, with strikes of $303 and $67. At the time of establishment and given the uptrend at the time, both the Covered Calls were sold with deltas around 0.20. Delta indicates the likelihood of the assignment of the option and the target delta is about 0.30. Deltas of 0.20 would have an even lower chance of assignment and would include higher potential price appreciation. In addition to low deltas, the Covered Calls were established at about 50% for both U.S. and Non-U.S. Developed positions. Only calls were sold on SPY, however the values of XLY, XLK, XLP and XLV were included in the value for which the SPY Covered Calls were sold against. At the close of June, both the $303 and $67 on SPY and EFA were still intact and deltas had trended lower.
Going into June, the VEGA portfolio already held Protective Puts with an expiration of December 2019 and strike price of $230, which at the time of establishment were approximately 20% out-of-the-money. Given the decrease in VIX during June, 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 on 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 June 2019. Lastly, the percentage of the portfolio covered by Protective Puts is just above 21% versus the target of 20%.
At the start of June, the 200-day moving average for the VIX was 17.25. Having recently completed a Volatility-Based Reinvestment on May 9, 2019, the established threshold for the next reinvestment was a VIX of 25.81 or 50% above the VIX 200-day moving average. During June 2019, the VIX opened at 19.41, hitting a high of 19.75 intra-month and closed at 14.06. Since the threshold was not breached during the period, no action was taken on the Volatility-Based Reinvestment cash.
VEGA rebalanced both SPY and EFA after the early closure of the second set of Covered Calls during June 2019. Both SPY and EFA were rebalanced back to a target of 43% and 9.50% respectively. SPY and EFA had not be rebalanced since March 2019, and given the strong overperformance of the SPY compared to EFA, the gains on SPY were rebalanced into the loss of EFA in order to maintain a target allocation.
At expiration, the Beta of the VEGA portfolio was measured to be approximately 0.63 to the S&P 500, inclusive of underlying holdings, as well as, all established option positions. This is within proximity to our target beta of 0.60. Although the June rebound was incorporated into the coverage of the options, because of the extended volatility experienced in Fourth Quarter 2018, 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 within the portfolio, the duration at the close of June 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 June, no adjustments were made to the duration. Duration may be adjusted after the Fed’s new dovish stance is reviewed in depth.
Global equity markets generally ended the second quarter of 2019 in positive territory despite a period filled with geopolitical uncertainty, ongoing international trade tensions, and key central bank decisions (or lack thereof). Market volatility and concerns about slowing global growth were not enough to stop equity market indices from reaching or nearing all-times highs.
The MSCI All Country World Total Return Index finished the quarter up 3.61%, while the S&P 500 and Russell 2000 Indices returned 4.30% and 2.10%, respectively. Developed international equity markets, as measured by the MSCI EAFE Total Return Index, were up 3.68% for the quarter, while Emerging Market equity bounced back from a rough May to a loss of just 0.39%.
Bespoke Investment Group keenly pointed out that as markets were moving towards all-time highs, bullish sentiment levels were “relatively muted in spite of this price action.” Interestingly enough, in the most recent American Association of Individual Investors (AAII) sentiment survey dated June 26, 2019, of the investors surveyed, 29.6% described themselves as “Bullish”, 38.4% described themselves as “Neutral”, and 32.1% described themselves as “Bearish”. Each of these categories saw little change over the previous survey, which is somewhat peculiar as demonstrated in Bespoke’s comparison between the S&P 500 price chart and bullish sentiment below:
According to the group, “Bullish, bearish, and neutral sentiment all simultaneously moving less than 0.1% is something that rarely has happened in the history of the survey… While it is a small sample size, [future] performance has generally leaned positive going forward, although we wouldn’t put much weight into it.”
Fixed income markets also ended the quarter on a very solid note, with the Bloomberg Barclays Global Aggregate Bond Total Return Index earning 3.62% and the Bloomberg Barclays U.S. Aggregate Bond Total Return Index gaining 3.47%. We do not, however, believe these returns are sustainable, and the rally in U.S. Treasuries sets the table for a possible future retracement.
What’s more, some were quick—and quite correct in our estimation—to point out that there is an extreme level of duration or interest rate risk present in fixed income markets. As noted by Bloomberg, the Macaulay Duration or the weighted average maturity of cash flows of a bond, which is one of several measures used to calculate the interest rate risk of fixed income instruments, of the Bloomberg Barclays Global Aggregate Bond Index is at a record high—nearly 8.4 years. According to State Street Global Advisors, the yield-to-maturity on the index is a paltry 1.59%.
The effective duration of the index, which factors in certain features of bonds like call or put provisions, is 6.98 years according to State Street—in other words, no matter how the data is viewed, investors are not compensated properly for adding duration. (As a side note, this is why we continue to keep the duration profile of our fixed income portfolios in a range of 1-3 years).
Turning to the U.S. economy, the third and final estimate of first quarter GDP growth came in at 3.1%, unchanged from the second estimate and 0.1% lower than the initial print, according to the U.S. Bureau of Economy Analysis (BEA). According to the BEA, the update included upward revisions to nonresidential fixed investment, exports, state and local government spending, and residential fixed investment which were offset by downwards adjustments to consumption and inventory investment. According to a Wall Street Journal survey of over 60 economists, second quarter GDP growth is expected to come in at 1.6%, while 2.2% growth is projected for full-year 2019.
A strong albeit shallow GDP print was not enough to halt the U.S. Federal Reserve’s increasingly dovish stance, which recently adjusted its forecasts in its June policy meeting. Despite keeping policy rates unchanged, the Fed modestly downgraded its expectations of economic conditions—in the face of a strong labor market and rising growth in household spending, the Fed noted softening business investment and weakening inflation. Fed Chair Jerome Powell in his post-meeting press conference highlighted the strengthening case for accommodative monetary policy, leading markets to price in a 100% chance of a July rate cut, according to the CME FedWatch tracker.
The Fed’s dot plot also showed a widening gap between the 17 voting officials. The median interest rate projection for 2019 was unchanged at 2.25-2.50% percent; however, seven officials expect 50bps of cuts this year, one anticipates one 25bps cut, eight expect no cuts, and one member expects a 25bps hike. In other words, the Fed is split nearly down the middle on which way rates should go—undoubtedly the July meeting will be extremely important as officials and analysts begin to parse second quarter data.
Source: Federal Reserve
The Fed’s dovish tone has already had an impact on financial conditions as a whole, as the Goldman Sachs U.S. Financial Conditions Index eased significantly over the quarter
The 10 year U.S. Treasury yield began the period at 2.49% before sinking to a multi-year low of 1.97% on June 19th—not-so-coincidentally the day of the Fed’s press release and Fed Chair Powell’s press conference.
The Fed’s moderated sentiment on the U.S. economy was also echoed by the U.S. consumer, as the Conference Board’s index of consumer confidence fell to 121.5 in June, its lowest level in 21 months. According to the Conference Board, consumers cited trade tensions as one of the primary catalysts for waning confidence. Lynn Franco, Senior Director of Economic Indicators at the Conference Board, highlighted how “escalation in trade and tariff tensions earlier this month appears to have shaken consumers’ confidence… although the Index remains at a high level, continued uncertainty could result in further volatility in the Index.”
Despite falling consumer sentiment, U.S. households appear to still be in solid shape. According to data released by the Federal Reserve, household debt as a percentage of GDP is at multi-year lows last seen in the pre-Crisis era. Unfortunately, the reverse is true for U.S. businesses, according to the Fed—business debt as a percentage of GDP is near its 2008-2009 peak.
Notwithstanding increasing amounts of corporate debt, according to Moody’s Analytics, the high yield default rate is still well below its long-term medium of 3.8%.
In the world of corporate earnings, FactSet reports that second quarter S&P 500 earnings are expected to decline at a rate of 2.6%, while revenues are expected to grow 3.8%. If these earning projections materialize, it will be the first time since Q1 and Q2 2016 that S&P 500 companies will have reported back-to-back earnings declines. For the full calendar year 2019, analysts are projecting just 2.7% earnings growth and revenue growth of 4.4%. In terms of valuations, as the S&P 500 continues to careen upwards, the forward P/E ratio is 16.6, above both its 5 year and 10 year averages of 16.5 and 14.8, respectively.
On the international front, the theme of uninspiring, slowing growth persisted across the board. Trade conflicts, financial strains, and unexpectedly sharp slowdowns in stronger, developed countries led the World Bank to cut its world economy growth forecast to 2.6% this year, the slowest calendar-year growth since 2016.
After reporting a 3.7% drop in April exports along with a 1.9% contraction in industrial output, Germany’s central bank cut its 2019 GDP forecast in half to just 0.6%. Bank officials commented in their update, “For economic growth and, to a lesser extent, for the rate of inflation, it is the downside risks that predominate as things stand today.”
As the Eurozone’s largest economy continued to struggle, the European Central Bank (ECB) took a markedly dovish tone, despite it being one of five central banks that already maintains a negative benchmark rate. As reported by Bloomberg in mid-June, ECB President Mario Draghi “cited rate reductions as an option” in the face of a dimming outlook for both growth and inflation. His comments sent the euro lower and also led to markets pricing in a 10 basis-point rate cut by December—which would bring the ECB’s policy rate to -0.50% from -0.40%. Claus Vistesen, chief euro-zone economist at Pantheon Macroeconomics, confidently stated that Draghi would “finish his tenure with a cut”, adding that “the door is now open and I don’t see how they cannot walk through it.” Draghi also received some ammunition for a possible rate cut in the preliminary June inflation report published by Eurostat—June inflation is expected to be a meager 1.2% annualized, the lowest print seen thus far this year.
The IHS Markit Flash Eurozone Composite PMI, which tracks both the services and manufacturing sectors, yielded mix results. On the one hand, the index reached a seven-month-high of 52.1 in June, 0.4 points higher than May’s 51.8 reading. However, despite the positive uptick, Chris Williamson, Chief Business Economist at IHS Markit, noted in his commentary, “Concerns about weaker economic growth at home and in export markets, rising geopolitical risks and trade wars continue to dominate the picture and dampen business spending, investment and sentiment.”
Japan’s Flash Manufacturing PMI dropped slightly to 49.3 in June from 49.8 in May, highlighting worsening conditions for Asia’s second largest economy for the second month in a row. Tim Moore, Associate Director at IHS Markit, noted “Japanese manufacturers continued to suffer from the slowdown in global trade volumes and weaker overseas demand conditions in June… Survey respondents linked the fall in exports to softer demand from customers in China, alongside a drag on sales from global trade frictions and weakness in the automotive sector.”
The hard data from the quarter also lent credence to the notion that the Japanese economy will continue to press on with uninspiring growth. June exports contracted for the 6th consecutive month (down 7.8%), although an early June update on first quarter GDP showed annualized real growth of 2.2% due to an upswing in capital expenditures. However, the revised figures also pointed towards weakening consumption going forward. According to the Japan Times, “analysts continue to emphasize the risk of a downturn due to sluggish personal consumption.”
Finally, China continues to face uncertainty on both the trade and domestic growth fronts. While the Chinese economy continues to see positive growth in key areas like retail sales (8.6% YoY), industrial production (5.0% YoY), and fixed asset investment (5.6% YoY), growth is occurring at an ever-slowing rate—a far cry from the booming economy seen in pre-Crisis era. It remains to be seen whether the government’s stimulus efforts will have a material, lasting effect. The International Monetary Fund believes China is heading for a growth rate of 6.2%, its lowest annual rate since 1990.
Source: ZeroHedge, Bloomberg
Markets and global trade participants received some much needed good news from the very recent G20 Summit in Osaka, Japan, as President Trump and President Xi Jinping agreed to resume trade talks. In order to bring China back to the table, President Trump agreed to delay tariffs on $300 billion of Chinese imports, while President Xi made a promise that China would purchase more U.S. farm goods. However, according to the Wall Street Journal, the key bargaining chip was a U.S. concession on Chinese telecom giant Huawei Technologies. The fine details are being hammered out by the U.S. Commerce Department, but will essentially allow the company to buy high-tech equipment from the U.S. as long as the parts don’t affect U.S. national security. One administration official says the licensing will contain “particular scrutiny of the threat that Huawei poses to our broadband networks, which are crucial to national security.”
Some expressed concern about the outcome of the summit, including Hannah Anderson, global market strategist with JPMorgan Asset Management, who remarked that markets have “seen this movie before… China and the U.S. talk, leaks from policymakers on both sides encourage speculation we are close to a deal, things fall apart, the U.S. presses forward with higher tariffs and markets express their displeasure with corrections and higher volatility.” Along a similar vein, U.S. Senator Marco Rubio commented from his official Twitter account, “If President Trump has agreed to reverse recent sanctions against Huawei he has made a catastrophic mistake. It will destroy the credibility of his administrations warnings about the threat posed by the company, no one will ever again take them seriously.” Undoubtedly, in the midst of slowing growth, U.S.-China trade policy will play a key role in keeping this near-record expansion alive.
The second quarter of 2019 confirmed in our minds that investors are indeed entering a period of “Great Moderation”. Despite strong first quarter growth in the U.S., the prospects are dimming—at home and abroad—with the effects of fiscal and monetary stimuli beginning to show signs of age. This has understandably led central banks around the globe to take a decidedly more dovish tone, for better or for worse. Nevertheless, we also see some bright spots amidst the fading backdrop—the U.S. consumer remains on strong footing and U.S. household debt as a percentage of GDP continues to fall, while lower interest rates could lend a needed boost to the housing market. Partnervest’s Investment Committee remains vigilant as we continue to monitor economic data points and trends in order to make investment decisions for the VEGA portfolio.
Both the final quarter of 2018 and the first quarter of 2019 saw several tactical changes to the STAR Spectrum portfolios. During late March 2019, the portfolios were de-risked by reducing both U.S. and Non-U.S. Equity allocations. Those funds were allocated into either cash or enhanced cash. Since that tactical shift, we feel confident about our current holdings and have not completed any new tactical shifts during the second quarter 2019. We continue to monitor the market conditions for opportunities to reinvest the cash and enhanced cash holdings. We appreciated your continued commitment to the VEGA strategy.
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.