Traphagen SmartHedge Update

Over the next couple weeks Traphagen will be upgrading the individual components of our SmartHedge program for clients as new, lower fee, and superior constructed products become available. We have partnered with the three financial institutions which have the most experience in researching and constructing volatility related hedge products. We will be incorporating securities from Deutsche Bank, Goldman Sachs, and JP Morgan within Traphagen's SmartHedgeprogram with differing allocations to each security based upon your personal risk objective. Below you will find a summary of the securities we are exiting and why, along with a summary of the new securities and our justification for the change.

 SmartHedge Securities we are exiting:

  • Royal Bank of Canada Risk Reduction Note: This is a note we entered in March of 2012 (when the S&P 500 was 1370) and promised 15% protection on the downside with up to 15% upside participation during an 18 month period. This 'maximum participation' on the upside represented just under a 10% per year return on the SP 500 which we were happy with, especially when coupled with the significant downside protection. As it turned out we did not need the 15% downside 'insurance' built into this product, but that is a good thing. You have insurance never hoping you actually need to use it.
    •    Total Return Realized: Our clients received a +15% return over 18 months or about 9.8% on an annualized basis.
    •    Rationale for Exiting: Even though we are pleased with the RBC note we were able to get superior terms with Goldman Sachs on the same type of risk reduction note. Our new note is 24 months in length, has an approximate maximum return over the period of ~23% (~10.7% per year return), and offers 12.5% downside protection. More importantly we are getting these terms at an S&P 500 level of about 1635 as opposed to the 1370 we entered the RBC note.
  • Deutsche Bank Emerald Volatility Hedge Note: We held Emerald as a volatility related hedge note that attempted to extract positive returns from higher volatility market periods (which usually occur during a correction) while 'fading into the background' in calmer periods. We were very pleased with this security as it tempered some of the volatility within the S&P 500 while providing significant excess return over simply holding the S&P 500. Holding this hedge was the equivalent of getting paid handsomely for insurance that you did not need to use.
    •   Total Return Realized: Our clients received a +28.7% return over 18 months or about 19% on an annualized basis. This total return was split with 22.4% of the total coming from the S&P 500 total return in the period and 6.3% derived from the Emerald Hedge itself.
    •   Rationale for Exiting: We of course were very pleased with Emeralds performance but feel using two separate specialized products in the future is the better allocation. In the past these two new products simply were not available and both should be superior at what their specific functions are (one a pure hedge and the other attempting to add positive returns in 'calmer' market periods) Emerald attempted to accomplish both. In addition, by utilizing the two new notes versus Emerald we were able to reduce the cost of the notes by 1%.
  • Barclays S&P Plus VEQTOR ETN: This is an ETN (exchange traded note) from Barclays that based upon market signals and volatility levels, allocated funds between US stocks and volatility itself. We were not displeased with the performance of the fund, but there were a few drawbacks that we can eliminate by transitioning from this note into our new suite.
    • Total Return Realized: Our clients received a +5% to +6% return since February or +7.1% to +8.5% on an annualized basis.
    •  Rationale for Exiting: Although the product produced solid returns and tempered volatility of the S&P 500, there are two main drawbacks that will be resolved with the new Hedge suite. One, this product produced no yield (vs. 2% for the S&P 500), and secondly because it always had at least some allocation to volatility itself, except in extremely volatile periods,  it would lag the general market. With the new suite of investments we attain the 2% yield return of the S&P 500 along with eliminating the 'volatility drag' on performance.

 New 2014-2015 SmartHedge Securities:

  • Goldman Sachs Risk Reduction Note: Our new Goldman Sachs note functionally is identical to the old RBC note with more advantageous terms. It is a 24 month, 23% maximum return (~10.7% per year max return), with 12.5% downside protection. More importantly we are getting these terms at an S&P 500 level of about 1635 as opposed to the 1370 we entered the RBC note.
  • Deutsche Bank ProVol Volatility Hedge Note:This note will take over the 'hedge' functionality of Emerald. We believe this product is a more efficient hedge versus Emerald for several reasons. Firstly ProVol was specifically designed as a pure hedge, whereas Emerald was more of a hybrid product. In addition it has the ability to 'shut off completely' if it sees no reason to hedge. The product correctly moved out of the way over the past year and allowed full participation in the impressive low volatility return of the S&P 500. In higher volatility periods (2008-2011) it took varying degrees of a hedge position and was able to extract very strong positive returns and effectively hedged a stock position. Although there is of course no guarantee it will do this in the future the historical hedging returns of ProVol outpaced those of Emerald. In addition using ProVol we are able to shave about 1% per year of fee for our clients vs. Emerald.
  • JP Morgan VolMont Volatility Note: This note will take over the 'carry trade' or 'added return' component of Emerald. This product was constructed specifically to take advantage of the volatility market in 'normal/calm' markets where it can produce excess returns over the S&P 500. In extremely high volatility periods (2008-2009) this can and did act as a hedge, but we are holding this predominately for diversification and added return in low volatility periods. Like ProVol in holding this note we have obtained a much lower cost structure versus Emerald.

Traphagen is always looking at improving every aspect of our portfolio management process, providing access to the best products in each category, and minimizing fees. Even though we were pleased with the risk reduction and added return offered through our original hedge suite, these new products offer a better overall product, lower risk, and a substantially lower fee. If you have any questions about the new or original SmartHedge suite please call you Traphagen financial advisor.

 

SPECIAL LOGISTICAL NOTE: It is important to note that through approximately 9/13/2013 apparent account value and cash level dislocations may occur. These apparent large daily account value changes are not 'real' and are just a function of the old notes maturing and the new notes entering the account before the settlement period. All account values should revert to their 'true' values by the end of next week.

 

 

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