December 9, 2010

Research Affiliates, ProShares Launch Long/Short ETF

Absolute returns based on fundamental indexes in a ‘market neutral’ portfolio

 

Research Affiliates and ProShares are teaming up with a new ETF, ProShares RAFI Long/Short ETF, which will start trading on the NYSE Arca under the symbol RALS Thursday, according to a joint announcement.

It is the “first public fund dedicated to the strategy,” and the beginning of a new “theme line” for ProShares, called the “Alternatives ETF Company,” Michael Sapir, (left) chairman and CEO of ProShare Advisors LLC, told AdvisorOne.com on Thursday.

The ETF is based on the Research Affiliate’s Fundamental Index. Unlike cap-weighted indexes which use a company’s share price or market capitalization to weight companies in the index, the Fundamental Indexes are based on four fundamental measures indicative of a company’s size, sales, cash flow, dividends and book value, according to Arnott. The RAFI measures mean that the ETF will go long companies that are the most undervalued by these metrics and short those that are the most overvalued.

In a sense, these metrics add an element of fundamental analysis to the selection of included companies that is not part of the standard cap-weighted indexes.

Because of this, the long side of the portfolio is invested in “deep value, out of favor” stocks, Rob Arnott, (left) founder of Research Affiliates, told AdvisorOne.com on Thursday.  

An investor in the ETF would have 100% of their investment in the long side of the portfolio, which Arnott says serves as collateral for another 100% invested in the short side of the portfolio, so investors get “twice the exposure, which brings down the risk," Arnott says. “The long/short neutralized market beta, the largest source of risk in broadly diversified portfolios.” He says he expects the strategy “to make money in both environments.” He adds that “the concept has been tried since 1990 with good success,” and has been used in the “Fundamental Index Long/Short Limited Partnership from back in 2004.”

Arnott explains that the fund is expected to be “largely market and beta neutral” over the long term, with a “little bit of [market] sensitivity on a short-term basis.” The fund’s fact sheet notes that it offers: “Absolute returns—potential for favorable returns regardless of market direction.”

Arnott adds that if the market is “up more than 30%,” they expect a “double-digit win,” and if it is “down more than 30%,” they expect a “double digit win.”

It’s a portfolio for an investor who wants an “asset that can give you alpha without market [beta] exposure, it could be one of the safe havens,” according to Arnott.

It’s “important to understand that 10% is a win—a good, solid year—regardless if the market is up 30% or down 30%,” Arnott asserts. “If you’re bullish on stocks, you’re not going to use this. If you’re ferociously bearish you could use it as a safe haven.”

In a nutshell, the fund goes “long companies that are bigger in their economic footprint than their market cap gives them credit for—deep value companies; and short high flyer growth companies—so [right now] long Verizon and Bank of America, and short Google and Apple,” Arnott notes.

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