Tag Archives: ptlc

The Double Edged Sword Of Trend Following ETFs

I’ve always been a big proponent of following the major trends in the market to serve as guideposts for sizing the stock allocation of my portfolio . Trend lines like the infamous 200-day moving average have never been a perfect predictor of stock market direction. However, using these types of technical indicators can serve as a useful tool for making incremental adjustments over time. Pacer ETFs is a relatively upstart company in the exchange-traded fund world that operates a suite of TrendPilot ETFs designed to automate the trend following process. Their lineup includes a range of well-known U.S. and European indexes with several hundred million in combined assets under management. The largest and most popular fund in their mix is the Pacer TrendPilot 750 ETF (BATS: PTLC ), which is based on the Wilshire U.S. Large-Cap Index. This includes a diversified basket of 750 large-cap stocks that aims for broader exposure than the stalwart S&P 500 Index. PTLC currently has $336 million in total assets and enough consistent daily trading volume to be considered liquid for most investor’s purposes. It also charges an expense ratio of 0.60%, which is on the high side for a typical ETF but not necessarily abnormal for a quasi-active approach. The basic premise behind PTLC is to participate when the stock market is going up and move to cash (or treasury bills) when it is going down. They accomplish this through a systemic, rules-based methodology that indicates when a positive or negative trend is established using the 200-day simple moving average. In an uptrend, PTLC owns 100% stocks. The fund then moves to 50% stocks and 50% treasury bills when the index falls below the trend line for five consecutive days. It then uses a final confirming indicator to move to 100% treasury bills if the simple moving average falls lower than its prior reading for five days. The process starts over again once the index regains its 200-day moving average on the upside. Simple. Logical. Automated. Sounds easy right? The obvious advantage of this strategy is that it is designed to keep your money safe during a prolonged bear market such as we experienced in 2008. Multiple months or even years of persistent selling pressure can be avoided by having your capital protected near the top quartile of a new down cycle. The goal is also to get you back into the market at a much lower point and with more starting capital than if you had held your way through on the downside. However, this trend following system also becomes a hindrance during periods of sharp corrections and subsequent rapid recoveries like we have experienced over the last year. The constant gyration from bullish to bearish momentum and back again creates a counter-productive effect on the strategy. When comparing PTLC versus the Schwab U.S. Large-Cap ETF (NYSEARCA: SCHX ) since inception, you can see how the trend following strategy moves to cash prior to the upswing in both 2015 and 2016. This means that you miss out on the recovery phase and end up rapidly falling behind the more conventional index. SCHX purely follows the Wilshire U.S. Large-Cap Index without the trend following component. The time period involved here is admittedly quite short and a proper analysis should be done over multiple cycles of the market. Nevertheless, it should be observed that this recent trading pattern does not sit well with a trend following strategy built to follow a long-term moving average . It may also result in some investors becoming frustrated with the timing component and jumping ship just prior to the market rolling over once again. The trend following ETF is ultimately doing exactly what its creators set out for it to do. The more recent price action should be considered a known risk of this type of enhanced index rather than a failure of the strategy altogether. The lesson is that there is always a double edged sword of opportunity cost that must be considered when you move to the safety of cash. This same risk is entrenched with the use of stop losses or physical sell orders for individual ETFs and stocks as well. They call it getting “whipsawed” and it is certainly an uncomfortable feeling when you are on the wrong end of it. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: David Fabian, FMD Capital Management, and/or clients may hold positions in the ETFs and mutual funds mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell, or hold securities.

New Trend-Following Fund Limits Your Downside

By Alan Gula, CFA Paul Tudor Jones (PTJ), a legendary trader and hedge fund manager, essentially predicted the stock market crash of 1987. In a PBS documentary, PTJ asserted, “There will be some type of a decline, without a question, in the next 10 to 20 months… it will be earth shaking… it will create headlines that will dwarf anything that’s happened up to this point in time.” On October 19, 1987 the S&P 500 dropped 20.5% in a single day. Many investors were eviscerated, and some traders were completely wiped out. That month, PTJ’s fund was up an astonishing 62%. PTJ is an ardent proponent of trend following. That is, you always want to be positioned with the prevailing price trend. If a security or futures contract is trending higher, then be long. If it’s trending lower, get flat (no position) or be short. So how do we determine the predominant trend? In an interview with Tony Robbins for Money: Master the Game , PTJ revealed that his preferred metric is the 200-day moving average of closing prices. Regarding the 1987 crash, Robbins asked, “Did your theory about the 200-day moving average alert you to that one?” PTJ responded, “You got it. It [equity index] had gone under the 200-day moving target. At the very top of the crash, I was flat.” The following chart helps illustrate what PTJ saw: Trend following has been around for ages. But now funds are popping up that automate the process. For example, the Pacer Trendpilot 750 ETF (BATS: PTLC ) was launched in June 2015. This exchange-traded fund (ETF) alternates exposure to the Wilshire U.S. Large-Cap Index (Index) or U.S. Treasury bills (T-Bills) depending on the trend indicators. Here are the allocation rules: Positive Trend Established: When the Index closes above its 200-day simple moving average (NYSE: SMA ) for five consecutive trading days, the exposure of the fund will be 100% to the Index. In other words, the fund will be fully invested in equities. Negative Trend Established: When the Index closes below its 200-day SMA for five consecutive trading days, the exposure of the fund will be 50% to the Index and 50% to 3-month T-Bills. Negative Trend Confirmed: When the Index’s 200-day SMA closes lower than its value from five business days earlier, the exposure of the fund will be 100% to 3-month T-Bills. These rules are designed to keep the fund invested when the stock market’s trend is up but to protect capital with the safety of T-Bills during down trends. Also, the rules attempt to minimize fund turnover during periods of high volatility. PTLC seeks to replicate the performance of a trend-following index. The chart below shows its back-tested results. The trend following index has outperformed over the long term with much smaller drawdowns (peak-to-trough declines). The benefits of trend following as a form of risk management can clearly be seen during the equity bear markets in 2001-2002 and 2008-2009 (yellow circles). The expense ratio of 0.6% for PTLC is a bit high, but the ETF does conveniently simplify the trend-following process. It’s worth noting that the ETF’s current exposure is 100% T-Bills, meaning that a stock market downtrend has been confirmed. The 200-day moving average is such a simple indicator that few people believe it offers valuable information. Also, with so much focus on daily catalysts and short-term moves in the media, the big-picture trend gets lost amid the din. The last time the S&P 500 crossed below its 200-day SMA was at the very end of 2015. I doubt PTJ was caught off guard by this year’s 10.5% decline through February 11.