Thursday, July 5, 2012


The neutral-zone trap: Positioning  ETFs to counteract volatile markets 
 
This is the second in a series. Next month: the chip and chase for rotational markets and goaltending styles for the last line of defense. 

In the previous issue, we discussed the need for a balanced and aggressive attack during neutral and positive markets. This month, we examine the neutral-zone trap for protecting against a potentially hostile market.
Setting the trap
When the opposition controls the puck in its own end, the neutral-zone trap can be used to counteract the rush before it develops into a major threat. In recent years, capital markets have appeared unpredictable for extended periods. They seem to react to one crisis after another, while dominating investors by keeping them off balance. Current events, rather than longer-term disciplines, seem to be most important.
Both Jacques Lemaire (Devils and Wild) and Guy Carbonneau (Canadiens) have leveraged the trap effectively to thwart attacks. Randy Carlyle, too, used it to coach Anaheim to the 2007 Stanley Cup (Leaf fans can dream on!). It was so effective that the NHL moved to strictly enforce obstruction rules, while allowing the two-line pass to make the trap less useful (see “Two-line passes,” this page).
Meant to disrupt momentum, players space themselves in the neutral zone in a 1-2-2 formation with one fore-checker looking to take advantage of a turnover. In a portfolio, this checker can be an aggressive equity fund like a small-cap or an emerging-markets fund that will respond quickly if the market trend suddenly turns positive (see “Fore-checker: aggressive small cap and emerging markets,” this page).
Two forwards block any attack lanes along the boards forcing the play toward the centre. These players must be ready to strike if they create a turnover. Broadly-based equity positions would serve this two-way function well, perhaps one domestic like XIC or VCE and one global/international like XWD, VEF or ZIN. (See “Forward: Canadian Equity,” and “Forward: global/international equity,” this page).
The two players on defence delay attackers while their forwards reposition to defend if no turnover can be forced. In a portfolio, these positions will depend on the risk tolerance of the investor. In a low-interest-rate environment, some return potential is important, but defence is the primary objective. High-yield or convertible bonds are risky, but offer better upside. Pairing with a defensive offset, like a short term/duration or laddered ETF, would provide the right mix of defence with offensive potential.  (See “Defence: high yield and convertible bonds,” and “Defence: short-term or laddered bonds,” this page).
Mounting a defence in the face of a powerful market onslaught can be a challenge. When volatility picks up, there are few tactics [DASH] other than cash or high-quality short-term bonds [DASH] that can preserve capital. Whether or not you have a sense about the kind of market threats ahead, ETFs can be useful players in positioning you correctly to defend and attack. AER

Thanks again to Dr. Jim Sugiyama, hockey savant, for his input.   

NOTE TO ART: This will likely be two pages

BOX
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SIDEBAR 1
HED: Two-line passes

SIDEBAR 2
HED: Fore-checker: aggressive small cap and emerging market funds

Exchange traded fund
Symbol
Mgt. Expenses
iShares Russell 2000 Index Fund (CAD hedged)
XSU
0.35%
Vanguard MSCI Emerging Markets Index
VEE
0.49%
iShares S&P/TSX SmallCap Index Fund
XCS
0.55%
BMO Emerging Markets Equity Index
ZEM
0.57%
Claymore BRIC ETF
CBQ
0.67%
Claymore Broad Emerging Markets ETF
CWO
0.71%
iShares MSCI Emerging Markets
XEM
0.82%

SIDEBAR 3
HED: Forward: Canadian Equity (broad lowest cost)
Exchange traded fund
Symbol
Mgt. Expenses
Horizons BetaPro S&P/TSX60 Index (swap)
HXT
0.07%
Vanguard MSCI Canada Index
VCE
0.09%
BMO Dow Jones Titans 60 Index
ZCN
0.16%
iShares S&P/TSX 60 Index
XIU
0.17%
iShares S&P/TSX Capped Composite Index
XIC
0.25%

SIDEBAR 4
HED: Forward: Global/International equity
Exchange traded fund
Symbol
Mgt. Expenses
Vanguard MSCI EAFE Index (CAD hedged)
VEF
0.37%
iShares MSCI World Index
XWD
0.45%
BMO International Equity Hedged to CAD Index
ZIN
0.50%

SIDEBAR 5
HED: Defence: High yield and convertible bonds
Exchange traded fund
Symbol
Mgt. Expenses
Claymore Advantaged Convertible Bond
CVD
0.45%
iShares DEX HYBrid Bond Index
XHB
0.45%
Claymore Advantaged High Yield Bond
CHB
0.56%
iShares U.S. High Yield Index
XHY
0.60%
XTF Canadian Convertible Liquid Universe
CXF
0.65%
Powershares Fundamental High Yield Corporate Bond
PFH
0.65%
BMO High Yield Corporate bond
ZHY
0.69%

SIDEBAR 6
HED: Defence: Short term or laddered bonds
Exchange traded fund
Symbol
Mgt. Expenses
Claymore 1-5 year Laddered Government Bond
CLF
0.17%
BMO Short Federal Bond Index
ZFS
0.22%
iShares DEX Short Term Corporate Universe + Maple
XSH
0.25%
Powershares 1-5 year laddered Inv. Grade Corp. Bond
PSB
0.25%
iShares DEX Short Term Bond Index
XSB
0.25%
Claymore 1-5 Year Laddered Corporate Bond
CBO
0.28%
BMO 2013 Corporate Bond Target Maturity
ZXA
0.30%
RBC Target 2013 Corporate Bond
ROA
0.30%
BMO Short Term Bond
ZCS
0.32%

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