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ETF News And Commentary

PowerShares, one of the biggest issuers of ETFs in the world, has been on the product development front a bit more as of late, reversing a trend in which the company seemed to be on a new fund hiatus. The firm recently launched a S&P 500 High Dividend ETF (SPHD), and now it has just put out its latest S&P 500 targeted product, the PowerShares S&P 500 Downside Hedged Portfolio (PHDG - ETF report).

This new fund marks PowerShares’ 171st product and a clear shift back towards domestic markets for the firm. It also looks to play on broad investor fears as well, potentially offering a lower risk way of playing the popular benchmark.

The ETF will follow the S&P 500 Dynamic VEQTOR Index, which is a benchmark that dynamically allocates between three asset classes; volatility, cash, and equities. This looks to provide investors with broad S&P 500 access with an implied volatility hedge (see Currency Hedged ETFs: Top International Picks?).  

The fund looks to dynamically allocate between equities (represented by the S&P 500) and volatility based on both implied and realized volatility levels. According to S&P, the target volatility allocation can range between 2.5%-- when implied volatility isn’t in a trend or down, and when realized volatility is less than 10%-- and up to 40% when realized volatility is at the high range (at least 35%) and if implied volatility is skewing towards an uptrend (see the full table in the PDF here).

In this way, the ETF looks to cycle into volatility when levels of realized and implied volatility are higher. Generally speaking, in these types of environments stock prices will not do very well, making an allocation to volatility a good choice.

However, when stocks are rising and volatility is moderate, this fund looks likely to underperform. This is due in part to the general underperformance of volatility as an asset class, and also as a consequence of constant futures rolling and resulting contango, which can really drive down returns (read Real Return ETF Investing 101).

Investors should also note that the fund isn’t cheap compared to unhedged products, as total costs come in at 39 basis points a year. Still, when markets are floundering and volatility is rising, this product can be worth the extra expense, as the underlying index significantly outperformed broad markets during the financial crisis of 2008.

ETF Competition

While PHDG may sound like a fresh concept, investors should know that an ETN version of the fund actually exists already. This product, the ETN+ S&P VEQTOR ETN (VQT - ETF report), tracks the same index as its new PowerShares counterpart and has amassed more than $340 million in AUM.

Yet the fund sees low trading volumes, so bid ask spreads could be wide, while it also charges much more than PHDG, costing investors 95 basis points a year in fees. With such a higher expense ratio, it could cause VQT to bleed assets to its cheaper competitor, although its structure as an ETN looks to prevent tracking error, a factor that could help it in the long run (see Three Low Beta ETFs for the Uncertain Market).

Either way, it looks like VQT will have some fresh ETF competition in the hedged, VEQTOR space. While it remains to be seen if PHDG can unseat its ETN counterpart from the top spot, it does seem pretty likely to attract cost-conscious investors who are looking for cheap ways to dynamically hedge their portfolios with the help of volatility.

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