Inverse Correlation
The T+ strategy is comprised of two major components; U.S. Treasuries[i] and limited risk volatility securities [ii] (long VIX puts). One of the many reasons we utilize these two components is due to their inverse relationship during times of market change.
Historically both components have a positive expected return, and due to their inverse relationship, when one is underperforming the other is usually outperforming. This helps reduce portfolio drawdowns, decreases volatility, and increases the expected rate of return.
T+ Component Time series
A constructive way of visualizing this inverse relationship is to examine a rolling six-month total return of the two component indexes used in the T+ strategy; the U.S. Treasury Index[iii] and Cassini’s custom volatility securities index[iv]. When we do this, the rolling six month returns have an inverse correlation of -0.52, which can be seen in the chart below.
While both components tend to spend most of their time above zero (having a positive trailing 6 month return), we can see that historically when one is underperforming the other component is usually outperforming helping to balance out the strategy.
T+ Component Scatter Plot
Another way to visualize this relationship is to use a scatter-plot of both components’ trailing six-month total returns. In the scatter plot below, all returns above the diagonal line represent a positive combined six-month return.
The top-right quadrant shows when volatility securities and U.S. Treasuries have been on an upward trend together. A strong positive correlation is desirable when both are producing positive returns, even though from a statistical point of view this reduces the overall negative correlation.
However, the negative correlation between the components becomes important when one is under stress. This advantageous negative correlation can be seen by a low number of data points in the bottom-left quadrant. Only 2% of the time are both components’ six month returns negative at the same time, and even then they are only slightly negative.
Also, important to note is that when only one component is negative (either the top-left or bottom-right quadrant) the other component is usually positive enough to offset the loss.
Conclusion
In summary, the unique and highly advantageous inverse relationship between U.S. Treasuries and VIX puts is a key strategic factor in the creation of the T+ strategy, and a large contributing factor to T+’s potential ability to produce superior risk adjusted returns.
[i]U.S. Treasuries: Represented by an investment in iShares 7-10 Year Treasury Bond ETF (IEF) with reinvesting dividends.
[ii]Volatility Securities: Represented by investments in Long VIX Index puts as determined by a proprietary algorithm. Cassini reserves the right to use other VIX futures traded products, such as but not limited to, The VelocityShares Daily Inverse VIX Medium-Term ETN (ZIV), or equity index option exchange traded products, such as but not limited to, WisdomTree CBOE S&P500 PutWriteStrat ETF (PUTW).
[iii]U.S. Treasury index: Represented by an investment in iShares 7-10 Year Treasury Bond ETF (IEF) with reinvesting dividends. From 01/01/2007 to 03/31/2018
[iv]Volatility Securities Index: Represented by a custom built Long VIX Put Index. From 01/01/2007 to 03/31/2018 Additional details are available upon request.
Cassini Capital Management, LLC (CCM), is an investment adviser registered with the State of Florida; however, such registration does not imply a certain level of skill or training and no inference to the contrary should be made. Additional information regarding the Strategy, including investment management fees, as well as important information regarding CCM, its services, compensation, and conflicts of interest is contained in the firm’s Form ADV Part 2 and is available upon request or at www.adviserinfo.sec.gov. This presentation is not intended for the giving of investment advice to any single investor or group of investors and no investor should rely upon or make any investment decisions based solely upon its contents. The TPlus(T+) Strategy may not be suitable for all investors as the appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives.
Limitations of Past Performance; Possibility of Losses: Past performance does not guarantee future performance. Participation in the Strategy carries the potential for profit as well as the probability of loss, especially over shorter time periods.
Other Fees and Expenses; Impact of Taxes: The investment management fee paid to CCM is separate and distinct from the internal fees and expenses charged by mutual funds and ETFs to their shareholders. These fees and expenses are described in each fund’s prospectus, and will generally include a management fee, internal investment, custodial, and other expenses, and a possible distribution fee. Prospective clients should consider all of these fees and charges when deciding whether to invest in the Strategy. Performance results for this strategy do not reflect the impact of taxes.
Comparative Benchmark Corporate Bonds (LQD) The iShares iBoxx $ Investment Grade Corporate Bond ETF seeks to track the investment results of the Markit iBoxx USD Liquid Investment Grade Index, composed of U.S. dollar-denominated, investment grade corporate bonds. Returns illustrated are net of fees.
Charts: All charts and graphs presented are property of Cassini Fund and were created for this presentation deck. Additional source material and statistical calculation details are available upon request.