RBS Launches New Trend-Following ETF

Although the ETF industry has experienced some growing pains in recent weeks thanks to a number of closures, the space is still undoubtedly expanding. This is best evidenced by continued inflows into the ETF space and a host of new fund launches in a number of key market sectors.

This trend continues here in September as the Royal Bank of Scotland has released its latest trend-following ETN, the US Large Cap Alternator Index Note ( ALTL - ETF report ) . The product looks to charge investors 1.0% per year in fees and hopes to give investors a new way to play the large cap market in ETN form.

In essence, the product will track the RBS US Large Cap Alternator index, which utilizes a relative strength strategy in order to decide which of the following three components to allocate assets to; the S&P 500 Index, the S&P 500 Low Volatility Total Return Index, or the S&P 500 Equal Weight Index (see 3 ETFs to Prepare for the Fiscal Cliff).

In this way, ALTL will always be allocated to a type of the S&P 500 benchmark, although it will have some flexibility in terms of its focus depending on which way the market is trending and which allocation methodology is outperforming.

ALTL Methodology

The note looks to dynamically allocate between the aforementioned three indexes based on observed price trends at the end of every calendar month. The product will take the simple average of the returns for the underlying indexes for the prior one, three, six, nine, and 12 month periods, allocating the full note towards the index with the highest average using these metrics (see Alternative ETF Weighting Methodologies 101).

Seemingly, this strategy will focus in on the low volatility version when broad markets are slumping, while the more small cap-centric equal weight index will probably be the note’s mainstay during surging market environments. Meanwhile, the ‘regular’ S&P 500 index will likely be the default when no true leadership is seen in the broad market.

Investors should also note the product structure of ALTL and that it is an ETN as opposed to an ETF. This means that the product is an unsubordinated debt security of RBS, and instead of holding the securities in the indexes, will nominally cycle between the benchmarks, pretty much eliminating tracking error and trading costs in the process (see ETFs vs. ETNs: What’s The Difference?).

ALTL in the RBS lineup

The new product represents a pretty novel way to invest in the markets that could have some appeal to investors seeking a play across business cycles. The strategy also represents the first departure for RBS from its ‘Trendpilot’ strategy, which is the basis for the company’s other seven ETNs.

These products, many of which have failed to garner investor attention, also employ simple moving averages in order to determine which asset class to invest in. However, these notes only have one choice; if the main asset is trending below its 200-day moving average, go to cash (3-month T-bills).

Since ALTL looks to always be exposed to the market instead, this marks the first time RBS has used a fully invested approach in its ETN lineup. Given this and the possible benefits of implementing this strategy in ETN form—lack of tracking error and trading costs by cycling between the benchmarks—this product could see a reasonable amount of interest from investors (see Are The Trendpilot ETNs Better than Broad Market ETFs?).

Yet with that being said, RBS will likely encounter some resistance from cost conscious investors as the product looks to charge far more than similar trend following products or broad market ETFs. In fact, if you add up the expense ratios for the three ETFs that are required for this strategy, ( SPY - ETF report ) (S&P 500 Index), ( SPLV - ETF report ) (S&P 500 Low Volatility Total Return Index), and ( RSP - ETF report ) (S&P 500 Equal Weight Index), you get a cost that is about 25% less than ALTL’s expense ratio.

This suggests that RBS believes that there is definitely some value—at least 25 basis points for sure—in using its ETN technique in order to accomplish this large cap rotational strategy. Whether investors agree with this philosophy and are willing to sacrifice a higher expense ratio for ease of use, remains to be seen, especially in this extremely liquid corner of the market.

Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report >>

Follow @Eric Dutram on Twitter

Author is long RSP