VEGA: August 2020 Portfolio Manager Review
Performance data quoted represents past performance and is no guarantee of future results. Current performance may be lower or higher than the performance data quoted. Investment return and principal value will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than original cost. Returns less than one year are not annualized. For the fund’s most recent standardized and month-end performance, please click www.advisorshares.com/etfs/vega.
|MSCI AC World Index||6.12%||4.75%|
|Cboe S&P 500 Buy Write Index (BXM)||2.59%||-9.56%|
|Bloomberg Barclays U.S. Aggregate Bond Index (AGG)||-0.81%||6.47%|
As of 8.31.2020.
In August the market continued the upward momentum it began in mid-April, making new highs. The S&P 500 Index closing out the month with a return of 7.19%. Fixed Income had lackluster returns with the Aggregate Bond Index (AGG) posting a -0.81%.
The top performers in August were U.S. Large Cap equity based positions with Technology (XLK) leading with a return of 11.88%. Other sector specific exposures did well with Communication Services (XLC), Consumer Staples (XLP), and Healthcare (XLV) with returns of 8.83%, 4.59% and 2.59%.
There was only negatively contributing position in August was Aggregate Bond Index (AGG).
|Ticker||Security Description||Portfolio Weight %|
|SPY||SPDR S&P 500 ETF TRUST||52.88%|
|EFA||ISHARES MSCI EAFE ETF||5.19%|
|XLV||HEALTH CARE SELECT SECTOR||4.98%|
|XLK||TECHNOLOGY SELECT SECT SPDR||4.94%|
|BLACKROCK LIQUIDITY T 60||4.78%|
|XLC||COMM SERV SELECT SECTOR SPDR||4.00%|
|IGSB||ISHARES SHORT-TERM CORPORATE||3.56%|
|MINT||PIMCO ENHANCED SHORT MATURIT||3.52%|
|XLP||CONSUMER STAPLES SPDR||3.52%|
|AGG||ISHARES CORE U.S. AGGREGATE||3.51%|
As of 8.31.2020.
August strike for the Covered Calls was nearly spot on. Back in July of 2020, VEGA sold SPY Covered Calls with a strike of 339. SPY closed at $339.48, just $0.48 above the strike set in July. However, because VEGA is run in a tax efficient manner, the Covered Calls were closed for $0.52 cents on the Friday of expiration to avoid assignment. When Covered Calls are In-The-Money, especially at expiration, the underlying will be sold out of the portfolio, which would have tax consequences for the strategy. Overall VEGA accomplished the goal it set out to achieve in August, which is participate in Price Appreciation up to the strike and gain additional return from the selling of Covered Calls. The return stream broken down on SPY for the month of August looks like this:
Strike – Starting Price = Price Appreciation
339 – 324.32 = $14.68
Option Sell Price – Option Buy Price = Option Premium
($1.53 – $0.52) * 75% = $0.76
Price Appreciation + Option Premium = Total Dollar Return for July to August Expiration
$14.68 + $0.76 = $15.44
This is a text book case of how Covered Calls are intended to work. It should be noted that VEGA gained an additional only an additional $0.76/share of SPY instead of $1.01, this is because VEGA only sold Covered Calls on 75% of the current holding of SPY shares.
They’re baaaaaaack! Welcome back to Protective Puts. Protective Puts exited the portfolio March 2020 and with the persistently high Volatility Index (VIX) they have been priced out of the portfolio until now. During the first week in August Protective Puts were integrated back into the portfolio. The market was trending strongly upward and approaching the previous high. It may seem counter intuitive to buy Protective Puts were the market is going up, but that is exactly when you should get them. December 2020 250 Protective Puts were purchased for 10% notional coverage of the portfolio. The idea would be that VEGA may have another opportunity to add move Protective Puts at a different strike or month in the near future, which would allow us to extend our protective should volatility return. Hopefully, by the end of September or early October another strike will be integrated into the portfolio, bringing the notional coverage up to 20%.
Volatility-Based Reinvestment (VBR) is a systematic way to deploying cash accumulated from the selling of Covered Calls or Strategic Cash back into the market when the market is trending lower. Having deployed 6 rounds of VBR in early 2020 the VIX would need to be significantly above its 200-day moving average before ash cash be reinvested. The 200-day trended upward to 27 at the start of August. Although the daily VIX has trended lower between March and August, the 200-day average continues to rise. This is because the large spike in early 2020 is now a major component of the average and the previously low VIX data points are dropping out of the average. VEGA would still need a VIX of at least 60 before deploying any additional cash.
VEGA continues to look for opportunities for Tactical Shifts. VEGA is currently satisfied with its current exposure to the global. While this means no recent Tactical Shifts were made during August and there are no intended ones for the future, VEGA will continue to seize an opportunities the present themselves in the current market environment.
When the new calls were sold against the S&P 500 in the beginning of August the beta of the portfolio was at .64. This is just slightly above our historical target beta of .60. The Beta of the portfolio may have in fact been higher during the month of August and that was intentional. The market was in the process of making new highs around August expiration, instead of immediately selling new Covered Calls and capping our upside price appreciation, VEGA waited until the Thursday following expiration, which allowed for VEGA to set the ceiling on the upside participation over 2% higher than if calls had been sold immediately after expiration.
Fixed Income continues to maintain a relatively low duration of 2.31, which is up slightly due to the changes in the underlying Fixed Income ETFs. VEGA continues to think that low duration is prudent give the market environment. Should more volatility return in late 2020 or early 2021, principle values of high duration Fixed Income positions will be impacted more than their lower duration counterparts.
During the month of August, as countries throughout the world worked to find a balance between virus mitigation and economic recovery, global and domestic stock markets continued their ascent. Globally, the MSCI ACWI posted a gain of 6.16% on a total return basis, bringing the index up 5.12% YTD. Benefiting from much of the same tailwinds, the MSCI Emerging Markets index notched a more modest return of 2.24% for the month, enough to push the index into the green YTD, up 0.68%. Domestically, like in July, all major indexes extended their now five-month period of gains. The S&P 500 experienced its best August since 1986, ending the month up 7.19%, with YTD gains of 9.74%. Over the 5-month period ended August 31st, the S&P has surged 35% over that period, its largest 5-month percentage gain since 1938. The Russell 2000 notched August gains of 5.63%, bringing the index closer towards positive territory YTD (-5.53% YTD through August 31st). Meanwhile, the old-economy dominant Dow Jones Industrial Average benefited from recent changes to its composition as it ended the month up 7.92%, though YTD the index is up only 1.30%.
On the fixed income side of the market, U.S. Treasury yields rose on bullish market momentum as well as the return of hopeful sentiment as COVID trends again began to improve domestically. Focusing on the Treasury Curve’s front-end, the 2-year Treasury began August at the low point of 0.11%, climbing as high as 0.16% before ending the month up modestly to 0.14%. The 10-year Treasury opened the month yielding 0.56%, rising to 0.74% before ending the month down only slightly from its peak at 0.72%. We expect yields to remain largely range bound going forward as the U.S. Federal Reserve confirmed it will leave borrowing costs very low for the foreseeable future at its August Jackson Hole Summit meeting. At this event, the Fed formally adopted an average inflation target, acknowledging the change “reflects [The Fed’s] view that a robust job market can be sustained without causing an outbreak of inflation” (Source: Federal Reserve).
In fixed income markets, as bullish equity tailwinds caused a sell-off of safe-haven assets in preference of higher yielding assets, most major bond indices ended August in the red. The Bloomberg Barclays U.S. Aggregate and Global Aggregate ended the month down 0.81% and 0.15%, bringing each index to 6.85% and 6.11% on the year, respectively. In contrast to the aggregate fixed income indices, the U.S. High Yield Master II returned 0.98% in August, bringing it to 0.75% YTD. However, the S&P 500 Investment Grade Corporate bond index fell 1.71% in August, bringing the index to YTD gains of 7.44%.
The August reprieve in COVID transmissions is one reason for the bullish trends in fixed income and equity markets. As the U.S. grew—and continues to grow—more experienced and capable in its fight against COVID, August saw the pace of new infections slow modestly according to data from Johns Hopkins University. Globally, total infections passed 25 million in the month as the U.S. reported domestic cases of roughly 6 million. In all, the U.S. added around 1.38 million cases during August, compared with the 1.87 million cases that were reported in July.
Declining transmission trends and bullish sentiment in the market are causing Wall Street analysts to be as optimistic as feasible in the face of a global pandemic. As reported by Lipper, the S&P 500 is expected to experience an earnings decline of 23% for the third quarter of the S&P 500. While none of the 11 S&P 500 sectors are expected to post any earnings growth relative to the third quarter of 2019, there are certain subsectors which stand to gain from COVID-related tailwinds. Information technology, which is only expected to post an earnings decline of 1.8%, has 5 of its 13 subsectors expected to increase 3Q earnings relative to last year. Healthcare, which has an expected earnings decline of 2.8%, has 6 of its 10 subsectors anticipating earnings growth over the same period.
As expected, the distance between Wall Street and Main Street as shown though economic indicators increased during August. Starting first on a confidence level, the outlook appears to be mixed depending on who the surveys asked. The Conference Board Consumer Confidence Index decreased again to 84.8, with the Present Situation index falling sharply from 95.9 to 84.2. Of interest, however, is that the portion of the survey reserved for leaders of companies saw an increase during the month, as the CEO Confidence Survey notched a 5% gain.
On the consumer front, as unemployment saw several weeks of increases throughout the month, this continuing fall of consumer confidence is of no surprise. As recreational and retail shutdowns go into their 7th month with no signs of a reversal, the crickets from Capitol Hill regarding additional stimulus measures ring loudly in the ears of the roughly 30 million individuals receiving unemployment benefits. Considering these benefits now amount to several weeks of significantly lower payouts to the unemployed, more adverse economic impacts are anticipated in the coming months.
During August, the domestic employment situation remained mixed. Though there were several weeks of increases in initial unemployment claims, they were met by an equal amount of weeks of decreasing initial claims, according to the Bureau of Labor Statistics (BLS). In total, as unemployment filings teetered between expansion and retraction territory, job postings allude to a brighter road ahead. According to data from LinkUp, a job listings dataset, through mid-August over one million new positions were published online. This figure is in line with the numbers from one year ago and highlights the encouraging rebound in job offerings from June through August.
Inflation, back in the news due to the Fed’s formal adoption of an average inflationary goal, is expected to increase in the future as shown by several leading indicators. The 5 Year-5 Year Forward rate, a measurement of the average expected inflation over the 5-year period that begins 5 years from today, rose to a six-month high of 2.07% before ending the month slightly below 2%, while the 10-year breakeven rate rose above 1.70% for the first time since January. This rate serves as an indication of the fixed income market’s inflation expectations over the next 10-year horizon.
As time progresses we continue to learn more about the extensive impact the pandemic has had on global economies. The CPB Netherlands Bureau for Economic Policy Analysis estimated that global flows for goods across borders were 12.5% lower in the three months through June compared to the first quarter of the year, marking the steepest decline since records began in 2000. The Eurozone saw its exports fall by 19.2% respectively for the second quarter, while China experienced a 2.4% increase following a 7.7% decline in the first quarter of 2020. Breaking these trade flows into their monthly components paints a picture of a responsive rebound, as flows rose by 7.6% globally in June due to partial global reopenings. Looking forward, the World Trade Organization (WTO) has estimated that trade volumes are likely to fall by 13% around the world this year compared with 2019.
The UK released their initial analysis of the country’s GDP from the second quarter in August. The UK Office for National Statistics estimated that GDP fell by a record 20.4% during the quarter, following a 2.2% decline in the first quarter of the year. On a positive note, however, the monthly data does show a pick-up in economic activity in June as government restrictions on movement were gradually lifted throughout the country. On a sector basis, there were record quarterly falls in services, production, and construction output as private consumption accounted for more than 70% of the fall in GDP.
Turning to the Eurozone, recent Purchasing Managers Index (PMI) data shows a slowdown in the pace of recovery underway for the economic region. The IHS Markit Eurozone PMI Composite Output Index fell to 51.9 in August, down from 54.9 in July. Breaking this down into its components, the main cause for the decline can be attributed to the sharp decline in the rate of growth for service sector activity. Although this industry recorded a second successive month of growth, the rate of growth was only marginal compared to that seen in July. In contrast, manufacturing output rose at the fastest pace since April 2018. On a country level, Germany was the best performing economy in the region, aided by its manufacturing-heavy economy, while Spain and Italy were weighed down by their service-focused economy to record outright declines in business activity.
While the rate of recovery is slowing, optimism regarding the immediate and longer-term future still remains widespread throughout the region. This can be seen in the most recent Economic Sentiment Indicator (ESI) report for August released by the European Commission. In it, the recovery of the indicator continues as it notched a 5.3 point gain for the Euro Area. In total, the ESI has recovered roughly 60% of the combined losses from March and April as the area sustains improvements in industry, retail trade, and services confidence. In contrast, confidence edged down in construction and remained largely stable amongst consumers. On a country level, the ESI increased most significantly in France, The Netherlands, and Germany while it experienced a significant setback in Spain.
Thank you for your continued trust in Partnervest.
Partnervest Advisory Services, Chief Investment Officer
AdvisorShares STAR Global Buy-Wrtie ETF (VEGA) Co-Portfolio Manager