Alpha Architect unveils tail risk ETF

Mar 9th, 2023 | By | Category: Alternatives / Multi-Asset

Alpha Architect has launched a new actively managed ETF designed to earn positive returns during significant downturns in US large-cap equities.

Alpha Architect launches tail risk ETF

The fund is designed to protect investors against severe downturns in the US equity market.

The Alpha Architect Tail Risk ETF (CAOS US) has been listed on Cboe BZX Exchange with an expense ratio of 0.63%.

The fund’s primary objective is to buffer against the possibility of ‘market dislocation events’, defined as a fall in the S&P 500 of more than 25% within a few months accompanied by a sustained increase in expected volatility (when the VIX Index surges above 50).

Examples of historical market dislocation events that have met both of these standards include the Financial Crisis of 2008-09 and the Covid-19 market crash of 2020.

Sub-advised by Arin Risk Advisors, a Pennsylvania-based financial advisory firm specializing in options-based investment strategies, the ETF utilizes combinations of put and call options, both long and short, that are referenced to US large-cap equity indices, primarily the S&P 500. Standardized as well as FLexible EXchange (FLEX) options are both eligible for inclusion in the portfolio.

Arin Risk Advisors aims to keep the ETF’s ‘Protection Ratio’ above 10 and as high as possible while attempting to minimize implementation costs. The Protection Ratio represents the number of protective options (long put options expiring with strike prices that are at least 5% below the S&P 500’s current value) compared to the total number of options represented by all the ETF’s assets.

In addition to the primary objective of protecting against market dislocation events, the strategy also aims to deliver on two other objectives: to gain a varying amount of exposure to US large-cap equities (between 40% short and 100% long exposure to the S&P 500) and to generate cash flows from receiving option premiums.

Under normal circumstances, the ETF is expected to allocate approximately 20% of its assets to gain exposure to the S&P 500, between 1% and 10% of its assets to protective options, while the remaining assets will be held as cash or invested in US Treasury securities and money-market instruments that will serve as collateral for the fund’s options positions.

Investors wishing to hedge against severe downturns in US equities may also wish to consider ETFs offered by Amplify ETFs or Simplify Asset Management.

The Amplify BlackSwan Growth & Treasury Core ETF (SWAN US), which launched in November 2018, consists of a 90% allocation to US Treasuries and a 10% allocation to LEAP options (long-term equity options that typically extend for two years or more) on the SPDR S&P 500 ETF Trust (SPY US). The LEAP options deliver an approximate 70% exposure to the S&P 500 over a full market cycle, while the allocation to Treasuries provides downside protection. SWAN currently houses $240m in assets and comes with an expense ratio of 0.49%.

The Simplify Tail Risk Strategy ETF (CYA US), meanwhile, came to market in September 2021. The fund invests up to 20% of its assets in an advanced options overlay that includes put options and put option spreads on broad market equity ETFs, long-volatility futures, interest rate futures and options, options on credit default swap indices, and foreign exchange futures. According to Simplify, the hedging strategy is designed to handle multiple types of market dislocations and is structured in such a way as to deliver a convex payoff – the ETF’s gains accelerate as equity markets fall deeper into negative territory. The fund’s remaining assets are allocated to income-generating fixed income ETFs, such as those that invest in REITs or MLPs, in a bid to help finance the fund’s option purchases. CYA has $20m in assets and an expense ratio of 0.84%.

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