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CLS: Inverse ETFs – Fed Funds Rate Hike – Income Investing


Week in Review
Equity markets declined during the first week of June. With first quarter earnings season wrapped up, there wasn’t very much to keep markets strong. Uncertainty regarding Greece escalated again, with a major debt payment due June 6. According to the U.S. Labor Department nonfarm payroll report, 280,000 net jobs were added in May. This, the largest number since December, increased the prospect of a 2015 rate increase, despite European pleas to wait until 2016.

For the week, the S&P 500 fell 0.65%, and the broad-based Russell 3000 Index declined 0.42%. International markets also came in flat for the week, with the MSCI ACWI ex-U.S. international index down 1.70%. Yield on the 10-year U.S. Treasury bond remained flat, ending the week at 2.41%. Yield on the 10-year Treasury peaked on Friday, June 5, surpassing 2.4%.

How Does the Inverse S&P 500 Position Work?
There is currently an inverse S&P 500 position in many ETF separate account portfolios. The key reason: diversification. But this position does create many questions for investors, like ‘How does it work?’ The position is paired with a long equity position and designed to lower risk in a portfolio without fully relying on bonds. In this fashion, it acts as a hedge against interest rates, as seen during the recent interest rate increase.

In our separate account portfolios, the position does not typically represent the full conservative allocation, but it works with bonds to diversify the conservative side of the portfolio.

Since April 20, 2015, the 10-year Treasury rate has risen almost 22 percent, from 1.9 to 2.3. The iShares Barclays Aggregate Bond ETF (AGG) dropped 2.5 percent during this time. The iShares S&P 100 ETF (OEF) is the long equity

position, which returned 1.55 percent. The ProShares Short S&P 500 (SH) is the short position that returned -1.18 percent

A portfolio of half SH and half OEF returned 0.19 percent versus an all-bond portfolio return of -2.5 percent. Thus, even though the SH return was negative, the SH approach has outperformed bonds by over 2 percent during this rising rate period!

Interest Rate Hike – The Waiting Game
I think we have all experienced this at some point: you go to the store, proceed to the checkout counter, and face the daunting choice of which line to enter. You pick one and stand there waiting in uncertainty. Every movement begs the question: Should I switch to the other line? We scope out which individuals look the most efficient and have the fewest items. I know that whatever line I choose will inevitably be the one that summons the manager after it’s too late to switch, despite the fact that I specifically chose the over-21 cashier to avoid these situations.

This feeling of uncertainty is very similar to the market’s anticipation of a Fed Funds Rate hike. Current Fed Funds Futures point to the first rate rise occurring in October, moved up from December, following strong nonfarm payroll data. During ECB discussions this week regarding Greece’s debt, International Monetary Fund Managing Director Christine Lagarde, pleaded to the Federal Reserve to wait until 2016 before proceeding with the first rate hike.

Every news event from the U.S. to Greece seems to tie to expectations of this increase, and the market is currently reacting to each one. Which line should we be in? September, October, December, January? The fact is, we don’t know how quickly it will come, but eventually the Federal Reserve will institute the first rate hike. Being prepared for all market conditions is what a globally diversified portfolio aims to accomplish. We will reach the cashier eventually, and then the uncertainty and anticipation will be forgotten. But until then, we’ll still be looking for the best line.

The Income Puzzle
As more baby boomers retire, more and more investors will need to rely on their savings and investments for steady income. How to fund this income has become a prevalent question among our clients. At CLS, we have a wide variety of options to meet systematic withdrawal needs.

We believe the primary focus should be on finding an allocation and strategy that keeps the client invested, regardless of market conditions. A systematic withdrawal does not need to be generated purely from dividends and interest. Sometimes, a diversified strategy is more appropriate. Addressing the following items should help identify the allocation and strategy that can lead to client success.

  • Identify the proper risk level – what type of volatility can the client handle and what type of growth is required to keep up with inflation and meet income needs?
  • Would setting aside some cash in a bucket system help the client feel more secure about withdrawals? This can be done using CLS strategies.
  • Are dividends and income more important to the client than their portfolio following along with market performance? If so, the CLS Managed Income Strategy may be the best fit. Income-oriented investments may lag the broader market in a rising rate environment.
  • Does the client need to see major selling activity in the account in an effort to protect assets during a major market decline? If so, the CLS Protection Strategy may be the best fit. The Protection Strategy cannot time these events perfectly; there may be some lag getting out of the market on the way down and lag getting back in when the market rises. This could result in some drag on performance versus the broader market.
  • Is the client primarily concerned with keeping up with the market and getting regular distributions into his or her checking account? If so, a diversified risk budgeted strategy such as the AdvisorOne Funds Strategy, Core Plus ETF Strategy, or Core ETF Strategy may be the best fit.


The graphs and charts contained in this work are for informational purposes only.  No graph or chart should be regarded as a guide to investing. While some CLS portfolios may contain one or more of the specific ETFs mentioned, CLS is not making any comment as to the suitability of these, or any investment product for use in any portfolio.

The S&P 500® Index is an unmanaged composite of 500-large capitalization companies.  This index is widely used by professional investors as a performance benchmark for large cap stocks.  The Russell 3000 Index is an unmanaged index considered representative of the U.S. stock market.  The index is composed of the 3,000 largest U.S. stocks. The Russell 2000® is an index comprised of the 2,000 smallest companies on the Russell 3000 list and offers investors access to small-cap companies. It is a widely recognized indicator of small capitalization company performance. The MSCI EAFE International Index is a composite index which tracks performance of international equity securities in 21 developed countries in Europe, Australia, Asia, and the Far East. The MSCI All-Countries World Index, excluding U.S. (ACWI ex US) is an index considered representative of stock markets of developed and emerging markets, excluding those of the US. The Barclay’s Capital U.S. Aggregate Bond® Index measures the performance of the total United States investment-grade bond market. The Barclay’s Capital 1-3 Month U.S. Treasury Bill® Index includes all publicly issued zero-coupon U.S. Treasury Bills that have a remaining maturity of less than 3 months and more than 1 month, are rated investment grade, and have $250 million or more of outstanding face value. The Equity Baseline (EBP) is a blended index comprised of 60% domestic equity (represented by the Russell 3000 Index) and 40% international equity (represented by the MSCI ACWI ex US Index), rebalanced daily. An index is an unmanaged group of stocks considered to be representative of different segments of the stock market in general.  You cannot invest directly in an index.

The views expressed herein are exclusively those of CLS Investments, LLC, and are not meant as investment advice and are subject to change.  No part of this report may be reproduced in any manner without the express written permission of CLS Investments, LLC.  Information contained herein is derived from sources we believe to be reliable, however, we do not represent that this information is complete or accurate and it should not be relied upon as such.  All opinions expressed herein are subject to change without notice. This material does not constitute any representation as to the suitability or appropriateness of any security, financial product or instrument.  There is no guarantee that investment in any program or strategy discussed herein will be profitable or will not incur loss.  This information is prepared for general information only.  It does not have regard to the specific investment objectives, financial situation, and the particular needs of any specific person who may receive this report.  Investors should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed or recommended in this report and should understand that statements regarding future prospects may not be realized.  Investors should note that security values may fluctuate and that each security’s price or value may rise or fall.  Accordingly, investors may receive back less than originally invested.  Past performance is not a guide to future performance.  Individual client accounts may vary.  Investing in any security involves certain non-diversifiable risks including, but not limited to, market risk, interest-rate risk, inflation risk, and event risk.  These risks are in addition to any specific, or diversifiable, risks associated with particular investment styles or strategies.

An ETF is a type of investment company whose investment objective is to achieve the same return as a particular index, sector, or basket. To achieve this, an ETF will primarily invest in all of the securities, or a representative sample of the securities, that are included in the selected index, sector, or basket.  ETFs are subject to the same risks as an individual stock, as well as additional risks based on the sector the ETF invests in. Long/Short Equity is an investment strategy utilized to minimize market exposure by taking long positions in stocks expected to appreciate along with short positions in stocks expected to decline.  Long/Short Equity is not guaranteed to provide a return; as with all investing, investors could end up with a net loss of investment capital and/or income.




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