$CYA must be one of the best tickers ever for an ETF, innit?
$CYA is the Simplify Tail Risk Strategy ETF. From their webpage:
[CYA] seeks to provide income and capital appreciation while protecting against significant downside risk to investors with a standalone solution for hedging diversified portfolios against severe equity market selloffs.
CYA will invest a substantial annual budget in highly convex equity-hedging strategies. We believe a modest allocation can be a valuable hedging tool during extreme downside equity events.
Due to this ongoing spend on tail risk hedges, investors should expect substantial declines in CYA’s value during years without a tail risk event. Therefore, it should only be used by investors comfortable with making ongoing purchases into CYA to maintain a constant hedge, or by short-term investors looking to hedge against an imminent, severe stock market decline.
Pretty clear, uh? It is the ‘classic’ tail risk hedge strategy. …or not?!? Let me tell you a story.
I use the ETF $TAIL in my Model Portfolio. $TAIL is the most straightforward, basic and dumb way to implement a tail risk strategy: every quarter it buys the same premium amount of put options on the S&P500. When volatility is up, it buys fewer options and when it is down, it buys more. The mechanics of the ETF are easy to understand but the downside is that this strategy wastes capital by buying insurance when it is not needed or too expensive. At 59bps, it is also a quite expensive dumb strategy.
The Holy Grail of tail risk hedging is to find a strategy that buys protection only a moment before is needed. That’s obviously impossible, despite what you might have seen on YouTube. But trying to find something a bit more clever is less sinful.
There is also a more prosaic diversification benefit in employing a couple of strategies instead of one. Options demand a fair amount of “timing luck”: there is a substantial difference if the market tanks immediately before or after a put expiration date. For all these reasons, I am always out scouring what the market has to offer and that’s how I stumbled on $CYA.
Its benchmark is $UVXY (1.5x VIX futures) but managers have discretion in how much premium to burn each period: $CYA is an active and discretionary product, the option spend can vary depending on market conditions and Portfolio Managers’ view.
Unfortunately, discretionality is a tool that cuts on both sides. In this post, I want to use $CYA as an example. I am not only referring to the possibility of a manager making the wrong decision but also highlighting the likelihood that, as the ETF buyer, you may be left in the dark about whether the observed outcome aligns with the manager’s expectations. If not, it’s crucial to understand why it occurred.
The big issue here is that, most likely, you cannot pick up the phone, call the ETF manager and ask them what’s going on. $CYA is a great example because the Simplify guys do a ton of podcasts & shit but…
Ok, let’s see first what happened:
Yeah, cropped the pic the wrong way…sry, anyway this is $CYA in the last year. Also, the graph is not on a log scale either, just pay attention that the drops you see on the right side of the graph are bigger in % compared to the one on the left (if you are thinking “wouldn’t taking again the pic cost you less time than writing all of this?”, you are the type of reader I want).
In a year when stocks went up, it is no surprise per se to see a tail fund perform like this. Also, the most dramatic plunge, those 4 red consecutive bars, happened towards the end of October, exactly after stocks hit a relative bottom and then climbed without ever looking back.
Let’s put a bit of context:
$CYA went down but it did so in a decisive fashion even compared to another tail fund (for some reason, PortfolioVisualiser does not have $CYA November and December data). Was it by design or did something break?
Roger Nusbaum, the person behind this blog, leaned more on the latter:
I felt sympathetic to him but others commented on his post highlighting the fact that if the market went down, $CYA would have jumped way more than $TAIL. Nothing to see here, basically.
What baffled me more is that I didn’t find any comment on this coming from the Simplify gang. Ok, I have to admit that Googling something these days is like asking a Japanese person to say “no”, you would never get what you are looking for. But I think I am a person who pays (too much) attention to these topics, mainly via Twitter, and Michael Green is on a media outlet almost daily. Roger and I may be the only ones interested in this type of answer? The point is, even in this era, you can only get a limited amount of access.
I wanted to raise what is happening “in real time” because this part of the process is frequently lost when someone runs a backtest, often because of survivorship bias.
We have to use these types of funds (as is, strategies not available as pure beta, like trend following) if we want to limit drawdowns typical of a 100% stock portfolio but then we incur these issues. No manager will always perform as expected: when to hire/fire a manager is one of the hardest tasks in this biz, even when you have access.
I can do my (very limited) due diligence but the truth is that I have to rely for the most part on third-party recommendations: I learned I can trust Meb Faber (to say a name) so I can count on his opinion when he talks about another manager. I also (sadly) learned that for the most part Talk Your Book by Animal Spirit is just a paid advertising gig and cannot trust what’s presented there. This process is better than nothing but it is time-consuming and not remotely sufficient anyway.
I just read Pyramid of Lies, the book about Lex Greensill, and it was an unnecessary reminder of the pitfalls of the above plan. Very few actors in the financial world do proper investment due diligence and even fewer are openly truthful about their findings. Greensill wasn’t an “innovative” start-up like Theranos, their mission was built on standard trade finance contracts: how can you go from “I fund invoices issued by highly rated companies with maturities around 90 days” to multi-year loans to start-ups backed only by promises of future revenues? Simple, because each investor thought every other participant was diligent enough to do their homework.
There is no real solution to this issue, either the investor is able to get a diversified exposure to the same strategy via different managers or it has to accept the ‘limited’ efficient frontier provided by standard asset classes. Between the two approaches there is not a clear winner.
Bonus Track
$SPD is the Simplify fund that combines SPY and vol protection, sort of $IVV + $CYA all in one.
Here is how the fund performed compared to a combination of $IVV + $TAIL and $IVV alone (as stated in $SPD presentation, I used a 3% option budget to create the second portfolio).
$SPD is designed to provide protection from SEVERE market downturns and there are none in the backtest so…I let you draw your own conclusions, if any.
The good news is that, between $CYA $SPD and $TAIL, you can buy different “levels of portfolio insurance”: just do not jump too much in&out between them because the most likely outcome will be that you find yourself insure-less right when you need it.
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