7 New Market-Neutral ETFs

03/28/2012 6:30 am EST


QuantShares’ new funds provide low correlation to the market, explains CEO Bill DeRoche. He tells MoneyShow how the various approaches can complement investors’ existing portfolios.

Kate Stalter: Today’s guest is Bill DeRoche, CEO of QuantShares. Bill, I know that just a few months ago, you launched a number of ETFs, categorized as “market neutral.” Can you explain what you mean about that?

Bill DeRoche: Yes. Market neutral means that for each dollar that an investor invests in our fund, they will have $1 of long exposure to equities, they will have $1 of short exposure, and $1 of cash exposure. In many instances that is referred to as dollar neutral, in addition to being market neutral.

Kate Stalter: There seem to be a number of different ETFs, as well. Say a little bit about what they are, and how they would fit into an overall strategy?

Bill DeRoche: Our funds, we refer to them as factors. Basically, factors are groupings of equities that help explain return differences among securities; they are distinct from industries.

A good example would be US Market Neutral Size Fund (SIZ). The idea is that we want to provide a very different return stream to investors, and by doing that we basically construct a portfolio that is both long and short, that allows us to insulate investors from market moves.

Additionally, the funds are sector neutral, so what you see is that the biggest determinant of the returns in the fund is going to be the theme that we are trying to emphasize, whether it be small securities, cheap securities, or high-quality securities.

What you end up with is a fund that has very low correlation to the overall market. So it provides investors with significant diversification.

Typically, most funds—if you look at a value fund that is long only—the biggest driver of the returns in that fund will be the market. It is typically 90% to 95% correlated with the market, where ours are going to be very low.

So investors are getting a very different return source, but at the same time, since we are building these funds from the largest US equities, they are getting a very liquid pool of assets, something that they can trade. It also provides transparency, since it is in ETF format.

So we do have seven funds. Three of them I would like to highlight as what we think of as strategic investments. They are basically assets that people can buy and hold; these strategies have typically delivered outperformance over significant periods of time.

These would be US Market Neutral Value Fund (CHEP); Our small size fund, its ticker is SIZ; and our quality fund, US Market Neutral Quality Fund (QLT).

We do have four other funds, but they tend to be more tactical in nature. They are basically focused on momentum and beta. The idea here is, there are a lot of volatility explained by both momentum and beta, but they tend to switch very rapidly. So we think of them as much more tactical investments.

Kate Stalter: Who would the other four be mostly appropriate for?

Bill DeRoche: Yeah, so the other four first and foremost would be people looking to hedge. It’s not uncommon for folks that have, say, exposure to a growth manager, that they have a lot of momentum exposure in their funds. So it is very easy to hedge that risk out if they don’t want to eliminate that particular manager.

At the same time, since momentum is a very large explainer of equity volatility, it is an easy way to take a view on whether momentum stocks are going to do well, or whether the market is going to go up and down with our beta funds. So again it is more for people that have a particular view over a shorter period of time.

Kate Stalter: Most of our listeners are invested in broad portfolios and various asset classes—fixed income and so forth. How would you suggest that these funds would fit into that overall investment strategy that they already have?

Bill DeRoche: These are typically thought of as liquid alternative investments. In the past, if you wanted to get exposure to these types of portfolios, you would need to purchase a hedge fund.

What we have done is basically take the rules for the investing and created an index from those rules, so these are passive funds. They are also registered under the Investment Act of 1940, so you have all the protections associated with it.

At the end of the day, you end up with a return source that is very different from your typical equity or fixed income portfolio. So these blend very nicely with basically anything. I would highly encourage people to look at these in terms of providing diversification; they can be thought of as more of an absolute return-type strategy.

Most people are looking for a diversifier, something with low correlation. The beauty with these is they do have a tremendous amount of liquidity associated with them, which is different from a lot of other asset classes that do have low correlation to the broad equity market.

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