Horizons rolls out ETFs with built-in “Black Swan” protection

May 30th, 2012 | By | Category: Alternatives / Multi-Asset

Canada-based Horizons ETFs and its affiliate AlphaPro Management have announced the launch of two innovative ETFs which seek to provide exposure to North American stock market indices, while providing protection from sudden and significant market declines, so-called “Black Swan” events.

Horizons rolls out ETFs with built-in "Black Swan" protection

The man who coined the term "Black Swan", Dr. Nassim Nicholas Taleb, is a consultant to the ETFs' sub-adviser, Universa Investments.

The Horizons Universa Canadian Black Swan ETF (HUT) and the Horizons Universa US Black Swan ETF (HUS.U) are the first ETFs to be launched that pair a tail-risk hedge with an equity index investment. The two ETFs have been listed on the Toronto Stock Exchange (TSX).

Universa Investments will act as sub-adviser on the ETFs, charged with managing the tail risk via its proprietary portfolio protection strategies.   Universa is an investment management firm that specialises in convex tail hedging and investing.

Universa was founded in 2007 by Mark Spitznagel, its Chief Investment Officer.  The firm’s Senior Scientific Advisor, Dr. Nassim Nicholas Taleb, is considered the premier specialist of Black Swan events and has had a working relationship with Universa since its inception.

With reference to investing, a Black Swan refers to a sudden and unpredictable event that has widespread systemic impact like the one witnessed during the financial crisis in 2008. Dr. Taleb, who coined the term “Black Swan”, has argued that Black Swan events happen far more frequently than investors anticipate and can have a devastating effect on an investor’s portfolio.

Universa has an investment discipline focused on tail hedging and was a pioneer in hedging risks for client portfolios prior to the events of 2008, reaching back to the late ’90s. Additionally, Dr. Taleb has been working with Universa for over a decade, acting as a constant sounding board for their ongoing tail risk research, as well as a key spokesman about rare events.  Such a role has helped Universa refine its protection strategies, which will be utilised in the Black Swan ETFs to attempt to provide protection from sudden and significant market declines.

Essentially, the investment objective of HUT is to provide investors with exposure to (a) the performance of the S&P/TSX 60 Index through a portfolio of equity securities and/or index funds and (b) an actively managed basket of put and call options that seeks to provide protection from significant market declines over rolling one-month periods and seeks to reduce the overall volatility of HUT’s returns.

Similarly, the investment objective of HUS.U is to provide investors with exposure to (a) the performance of the S&P 500 Index through a portfolio of equity securities and/or index funds and (b) an actively managed basket of put and call options that seeks to provide protection from significant market declines over rolling one-month periods and seeks to reduce the overall volatility of HUS.U’s returns.

Howard Atkinson, President & CEO of Horizons ETFs, said: “I think many Canadian investors want to be fully invested in stocks but they are afraid of having to weather another serious stock market decline. The Black Swan ETFs are simply index ETFs with a hedging component that should provide protection from the kinds of significant declines that keep investors up at night,” said Howard Atkinson, President & CEO of Horizons ETFs. “The Black Swan ETF portfolios are designed to provide investors with exposure to the upside potential returns of the underlying stock index while also providing protection from their most serious and sudden declines, so you can invest with crash protection built in.”

A portion of each Black Swan ETF will be invested in an options protection strategy run by Universa, which is known as the Universa Black Swan Protection Protocol (Universa BSPP). The Black Swan ETFs will seek to capture the upside gains of the applicable stock index while the Universa BSPP seeks to avoid losses in the event of a significant market decline over a one-month period.  Other than during significant market declines, the costs associated with the implementation of the Universa BSPP will generally result in a drag on the performance of the Black Swan ETFs. (See diagram below).

Specifically, the Universa BSPP seeks to reduce the downside, or “left tail” risk, which is the occurrence of a significant market decline, such as a market shock or generalised market crash. The Universa BSPP attempts to provide increasingly greater returns as the applicable index moves further downward during a Black Swan event. During such significant market declines, revenue generated from the Universa BSPP, if any, will be reinvested into the equity portion of the Black Swan ETF’s portfolio.

“Not only do investors get protection from a significant market decline, but any gains generated from Universa’s protection strategy will be reinvested into the stock portion of the portfolio at times when valuations in the stock markets are the least expensive,” said Atkinson. “If a Black Swan event were to occur, investors in the Black Swan ETFs have the opportunity to achieve superior compounded growth over the long term, compared to a passive investment in the underlying stock index, by reducing the drawdowns of the investment.”

Portfolio protection strategy

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