A Potential Solution for Navigating Volatility
On a recent podcast, WisdomTree Senior Investment Strategy Advisor Jeremy Siegel outlined his thesis for greater market volatility over the near term, resulting from inflation pressures in the macroeconomic system and an aggressive Federal Reserve policy stance necessary to counter them.
Yet because of inflation, the return to bonds can be challenged and Siegel still likes equities for their long-term inflation-hedging characteristics. Companies do a reasonably good job of passing along their rising input costs to consumers, which helps preserve profits and dividends.
The current macro backdrop poses a challenge for investors who desire equity market participation but have concerns about volatility. That became a key motivation for the recent launch of the WisdomTree Target Range Fund (GTR).
We discussed this macro setup and the strategy behind target range strategies in detail on Behind the Markets, a podcast brought to you by Jeremy Schwartz, WisdomTree’s Global Chief Investment Officer.
In this episode, Jeremy talks to Michael McClary, CIO of Valmark Financial Group.
Listeners will hear about:
- McClary’s background with Valmark as an ETF strategist. McClary has one of longest track records managing ETF portfolios. Further, there are thousands of financial plans that come through the Valmark team, so McClary and his team bring a unique vantage point to solutions that address the most common client pain points.
- The challenges McClary sees in building actively managed portfolios, and why ETFs are a preferred vehicle for Valmark clients.
- The principles of global diversification, and why Valmark constructs its ETF models with close to a 70/30 mix of U.S. stocks and international stocks.
- Why McClary designed the TOPS Target Range Index family that motivated the launch of GTR.
- The desirability of the WisdomTree Target Range Fund (GTR) from McClary’s perspective.
- Equity valuations are historically high, particularly for large-cap U.S. stocks.
- U.S. fixed income is in a very precarious situation:
- Interest rates are low.
- Inflation is rising (negative real rates in many fixed income securities).
- Credit spreads are tight.
- Many investors may want more equity exposure but are not comfortable with the additional volatility that traditionally accompanies it. Strategies like GTR, which utilize options, can potentially help give more defined target ranges for returns and may help mitigate the volatility that comes from traditional equity investing.
- WisdomTree has often said with the current macro backdrop, the 75/25 equity/bond portfolio is our new 60/40. Others might look at the 70/30 equity/bond mix as the new 60/40.
- GTR is one option for how one can consider adding that additional 10%–15% equity exposure into a global multi-asset portfolio.
- A summary of GTR positioning:
- The Fund invests in one-year call spreads that are reset the third week of each January.
- The underlying allocation of option call spreads across global ETFs:
- 50% SPDR® S&P 500® ETF Trust (SPY)
- 20% iShares Russell 2000 ETF (IWM)
- 20% iShares MSCI EFAE ETF (EFA)
- 10% iShares MSCI Emerging Markets ETF (EEM)
- Restrikes of options positions occur if the value of an underlying ETF exceeds the strike price of the short call (cap) at any month-end (excluding December and January).
- The strike prices of the option call spreads in GTR are:
- Set 15% in-the-money (below the current price), and this is what potentially helps hedge market risk on the downside.
- The short calls are sold 15% out-of-the-money (higher prices), which is what defines the top end of the target range strategy before any restrike events may occur.
- McClary discussed the monthly restrike as something to help preserve further upside participation and not be capped for a full year on your upside of the market.
- How is the downside of the target range strategy managed? When you invest $100 in GTR, you are essentially going to see a portfolio that feels like $80–$85 of cash and collateral and $15–$20 of option premium.
- To be specific, as of October month-end, there was approximately $81 of collateral in the Fund and $19 of long option premiums. That long call option premium could certainly fall to zero value if the markets were to fall below the strike price of those long call options. But the cash and collateral in the Fund is what preserves the value of the Fund and provides the target downside range of the Fund.
This is a very innovative new strategy, and WisdomTree was excited to work with McClary and the Valmark team to bring it to market.
You can listen to the full episode below:
Important Risks Related to this Article
There are risks associated with investing, including possible loss of principal. The Fund is actively managed and implements a strategy similar to the methodology of the TOPS® Global Equity Target Range™ Index (the “Index”), which seeks to track the performance of a cash-secured call spread option strategy. There can be no assurance that the Index or the Fund will achieve its respective investment objectives or that the Fund will successfully implement its investment strategy. Moreover, while the Fund seeks to target returns within a prescribed range, thereby minimizing downside investment loss, there can be no guarantee that an investor in the Fund will experience limited downside protection, particularly short-term investors, investors that seek to time the market and/or investors that invest over a period other than the annual period.
The Fund’s options strategy will subject Fund returns to an upside limitation on returns attributable to the assets underlying the options. The Fund’s investments in options may be subject to volatile swings in price influenced by changes in the value of the underlying ETFs or other reference asset. The return on an options contract may not correlate with the return of its underlying reference asset. The Fund may utilize FLEX Options to carry out its investment strategy. FLEX Options may be less liquid than standard options, which may make it more difficult for the Fund to close out of its FLEX Options positions at desired times and prices. The Fund’s use of derivatives will give rise to leverage, and derivatives can be volatile and may be less liquid than other securities. As a result, the value of an investment in the Fund may change quickly and without warning, and you may lose money.
Investment exposure to securities and instruments traded in non-U.S., developing or emerging markets can involve additional risks relating to political, economic or regulatory conditions not associated with investments in U.S. securities and more developed international markets. These and other factors can make investments in the Fund more volatile and potentially less liquid than other types of investments. Please read the Fund’s prospectus for specific details regarding the Fund’s risk profile.
Professor Jeremy Siegel is a Senior Investment Strategy Advisor to WisdomTree Investments, Inc., and WisdomTree Asset Management, Inc. This material contains the current research and opinions of Professor Siegel, which are subject to change, and should not be considered or interpreted as a recommendation to participate in any particular trading strategy or deemed to be an offer or sale of any investment product, and it should not be relied on as such. The user of this information assumes the entire risk of any use made of the information provided herein. Unless expressly stated otherwise, the opinions, interpretations or findings expressed herein do not necessarily represent the views of WisdomTree or any of its affiliates.
Jeremy Schwartz has served as our Global Chief Investment Officer since November 2021 and leads WisdomTree’s investment strategy team in the construction of WisdomTree’s equity Indexes, quantitative active strategies and multi-asset Model Portfolios. Jeremy joined WisdomTree in May 2005 as a Senior Analyst, adding Deputy Director of Research to his responsibilities in February 2007. He served as Director of Research from October 2008 to October 2018 and as Global Head of Research from November 2018 to November 2021. Before joining WisdomTree, he was a head research assistant for Professor Jeremy Siegel and, in 2022, became his co-author on the sixth edition of the book Stocks for the Long Run. Jeremy is also co-author of the Financial Analysts Journal paper “What Happened to the Original Stocks in the S&P 500?” He received his B.S. in economics from The Wharton School of the University of Pennsylvania and hosts the Wharton Business Radio program Behind the Markets on SiriusXM 132. Jeremy is a member of the CFA Society of Philadelphia.