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%