Stocks plunged this morning following the release of red-hot employment data. In another blow to the Fed’s anti-inflation campaign, U.S. payrolls increased by 263,000 in November, well over the 200,000 expected by economists. Today marks the final monthly jobs report before the Fed’s two-day policy meeting on December 13 and 14. Investors hope the central bank will begin to scale back from the prior 75-point rate hikes. Treasury yields jumped in early trading in anticipation of continued Fed aggressiveness.
Today we’ll discuss the risk-on/risk-off strategy that allows investors to maintain exposure to equities when the environment is positive and mitigate the extent of drawdowns while remaining invested as much as possible.
Global X Adaptive U.S. Risk Management ETF (ONOF) is designed to maintain exposure to the equity markets when the environment is positive and then move to a risk-off position when that trend reverses. The passively-managed portfolio provides exposure to the S&P 500 when conditions look favorable but rotates into 1-3 year Treasuries when market conditions look bad. The strategy seeks to mitigate the extent of drawdowns while remaining invested in equities as much as possible.
The methodology for this fund is a little more complicated than what you find in the typical ETF. The idea is that it looks at various technical indicators to make an allocation decision. The index is based on historical data from two short-term indicators: Moving Average Convergence Divergence (MACD) and the level of the CBOE Volatility Index (VIX), as well as two long-term indicators: 200-day Simple Moving Average (SMA) and market drawdown percentage.
The trigger threshold for each signal is based on a predetermined Z-score. If the portfolio is in equities, it takes three negative indicators to switch the exposure to Treasuries. Once in Treasuries, it takes two positive indicators to switch to equities, thus, creating a higher hurdle to get out of the market than it is to enter. Based on the strategy, turnover in the portfolio should be higher than in a buy-and-hold approach.
