As an alternative to a straight-shooter S&P 500 equity fund, Simplify US Equity Plus Downside Convexity ETF (ticker: SPD) offers exposure to US Large Cap stocks with a strategic secondary component of put options aimed at managing the impact of severe market drawdowns.
In a nutshell, the fund is 98% committed to a S&P equity index fund while utilizing the remaining 2% on put options as an insurance policy.
This 2% insurance policy is actively managed in a manner that kicks in especially during severe drawdowns.
Given the unique strategy of this fund is it an enticing alternative worthy of consideration for contrarian portfolios?
Let’s find out in our SPD ETF review.
SPD ETF Review: Alternative S&P 500 Fund with Options
Simplify US Equity PLUS Downside Convexity Fund Review
Hey guys! Here is the part where I mention I’m a travel vlogger! This blog post (ETF review) is entirely for entertainment purposes only. Do your own due diligence and research. Consult with a financial advisor.
Seriously, I’m a YouTuber not a financial professional, so take what I say with a grain of salt; okay? Cheers!
Simplify, as a relatively new ETF provider, has made a cannon-ball like splash in recent months for its unique product range.
Given its Motley Crew ensemble of savvy yet contrarian industry veterans forming the collective braintrust behind the strategy of these funds, the waves they’ve been creating has certainly caught my attention.
So far, I like what I’ve seen and heard from the team over at Simplify.
Few ETF specialists have churned out enticing alternative investment products at a greater rate than I’m currently aware of.
As a follower of ETF Hearsay on Twitter, I’m impressed by how quickly the Simplify team has been able to move from the conceptual stage of product development to actual investable retail ticker products.
However, given the increasingly fierce competition in this space of alternative equity investments, is the strategy being offered by SPD enough to entice investors?
Source: Simplify on YouTube
Simplify US Equity PLUS Downside Convexity ETF Fund Overview, Holdings and Info
The investment case for “Simplify US Equity PLUS Downside Convexity ETF ” has been laid out succinctly by the folks over at WisdomTree: (source: fund landing page)
“The Simplify US Equity PLUS Downside Convexity ETF (SPD) seeks to provide capital appreciation by offering US large cap exposure while aiming to boost performance during extreme market moves down via a systematic options overlay.
The fund’s core holding gives investors a low-cost, index-based exposure to US large caps. A modest option overlay budget is then deployed into a series of options positions that help create downside convexity in the fund.”
Simplify US Equity PLUS Downside Convexity SPD ETF Fund: Principal Investment Strategy
To better understand the process of how the fund operates, let’s turn our attention towards the prospectus. (source: summary prospectus)
Principal Investment Strategies of the Fund
“The adviser seeks to achieve the Fund’s investment objective by investing primarily in equity securities of U.S. companies and applying a downside convexity option overlay strategy to the equity investments.”
U.S. Equity Strategy
“Under normal circumstances, the Fund invests at least 80% of its net assets (plus any borrowings for investment purposes) in equity securities of U.S. companies, primarily by purchasing exchange-traded funds (“ETFs”). The U.S. equity strategy is passive, meaning the adviser does not frequently trade U.S. equities but seeks to maintain consistent exposure to the U.S. equity market.”
Downside Convexity Option Overlay Strategy
“The downside convexity option overlay consists of purchasing exchange-traded and over the counter (“OTC”) put options on the S&P 500 Index or an S&P 500 Index ETF. When the Fund purchases a put option, the Fund has the right, but not the obligation, to sell a stock or other asset at a specified price (strike price) within a specific time period.
The downside convexity option overlay is intended to protect the Fund from losses. If the market goes down, the Fund’s returns may fall less than the market because the adviser will sell or exercise the put options. The adviser selects options based upon its evaluation of relative value based on cost, strike price and maturity.
Convexity in the Fund’s name is a reference to the mathematical term convexity. The Fund’s losses, if any, are anticipated to show convexity because the relationship between the Fund’s and market declines is not designed to be linear. That is, if markets decline in a linear fashion, the Fund’s returns are expected to decline slower than the market.”
SPD Specific Strategy
Firstly, let’s examine the value proposition of this fund over a traditional 60/40 or 80/20 portfolio.
60/40 and 80/20 portfolios have historically shaved down their exposure to equities in order to accomodate fixed income.
The historically uncorrelated benefits of a stock/bond combination has worked remarkably well for investors in recent decades.
The downside is of course less exposure to equities.
Less gas = lower returns
More bonds = smoother ride
SPD isn’t at all a fan of shaving down its equity exposure.
Instead, it takes more of a knick, snip or teeny-tiny trim to its hypothetical equity only beard to maintain a position of 98% invested in US large cap equities.
It believes equities are the best game in town.
With bonds yielding historically low rates does lowering your exposure to equities make sense from a risk/return standpoint?
Right now. Maybe not.
An insurance policy is the solution of SPD.
The strategy of being invested at a much higher rate than 60/40 and 80/20 portfolios (98% to be specific) when times are good means only 2% of the strategy is going to waste (options insurance).
When times are bad, and the worse they get the more the options overlay kicks in, the insurance policy is eagerly redeemed limiting the overall carnage caused by equities.
How Does a Put Options Overlay Work?
This is a investing blog written by a YouTube’n travel vlogger.
Thus, we’re not going to dive as deep into the ins and outs of a downside convexity strategy that you might find in other more technical reviews.
Granted, we’ll still attempt to cover when this strategy kicks in its insurance like protection.
In essence, the 2% of the portfolio that buys put options against the S&P 500 index acts as an insurance policy against equity bear markets.
The put options ladders budget for this specific fund has both a medium range options #1 (6m) + #2 (9m) and long range options #1 (12m) + #2 (15m) for a total of four components at 0.5% each.
The put options collect their insurance policy if the S&P falls below the given strike price.
If not. The insurance policy is wasted.
You’re still 98% invested in S&P equities any which way.
For those not totally familiar with this strategy I recommend this Put Option example article from Investopedia as additional reading.
SPD ETF Pros and Cons
- Intriguing total replacement option for an S&P 500 only fund providing an additional diversifier (put options)
- A potential diversifier that can be combined with other diversification strategies within the portfolio
- A reasonable gross expense ratio of 0.53 to add an alternative strategy to your portfolio
- A portfolio insurance policy that kicks in at just the right time (when markets are down the most)
- An alternative strategy that keeps the fund aggressively invested in equities (98%) while still offering downside protection
- A product that utilizes the specific knowledge and skill-set of its management team (Eg: Convexity Maven)
- A way to say sayonara to a milquetoast only portfolio of 60% market-cap equities and 40% aggregate bonds
- In competition with other alternative equity strategy products that offer an expanded canvas plus a secondary uncorrelated asset class (treasuries/gold) with long-term positive expected rates of return (NTSX, SWAN, GDE, etc) that may long-range outperform SPD
- Oddly enough the gross expense ratio 0.53% (which I mention as a positive) may not entice ultra-low fee fanatic investors
- Enough tracking error during an extended bull-market where investors may wonder: Why do I have this insurance policy in the first place?
How Does SPD Fit Into A Portfolio?
Core Portfolio Holding?
SPD has the potential to be a core holding that replaces a S&P 500 style of index fund.
In a traditional 60/40 portfolio you’d instantly be adding the strategy of a put option overlay insurance policy: an instant alternative sleeve in your portfolio.
Hence, you’d suddenly be going from 1-2 stock/bond relationship to 1-2-3 stock/bond/alternative form of diversification where you gain an additional diversifier.
I’m personally not a S&P 500 only equity investor.
But if I were, I’d gladly choose SPD to replace entirely my index exposure still affording me 98% equity coverage.
Putting my own investing biases aside, if presented with a must-choose scenario of S&P 500 or SPD…
SPD without a doubt.
I’ll take the insurance policy and stay 98% invested.
For 60/40 S&P only investors the strategy would like this:
60% S&P 500 + 40% BONDS —-> 60% SPD + 40% BONDS
For a globally diversified portfolio the result would look like:
30% SPD + 30% (EAFE + EM) + 40% BONDS
Expanded Canvas Portfolio Holding?
One potential way to benefit from the diversification benefit SPD offers would be to pair it with a couple of WisdomTree 90/60 and 90/90 products to maintain an aggressive position in US equities while pursuing three different diversification strategies.
Let’s use the example of a portfolio exhibiting US home country bias.
20% SPD (98% Equities + 2% Put Options) + 20% NTSX (90% Equities + 60% Treasuries) + 20% GDE (90% Equities + 90% Gold)
In this scenario you’d keep a 90%+ exposure to US large cap equities while adding multiple diversification return stacking strategies of bonds, gold and put options.
The remaining 40% of the portfolio could be used to add more equities, bonds and/or alternative funds in a manner that tickles your fancy.
This portfolio would have a true multi-strategy approach to diversification.
For sophisticated investors this is definitely something to consider.
Nomadic Samuel Final Thoughts
This is the first review on my blog where the associated ETF doesn’t make it into my portfolio.
Although I love the concept of an options overlay as a ‘diversified diversifier’ to protect against extreme cases of downside volatility, SPD doesn’t offer ‘enough else’ to make the grade.
I’ve written several posts covering why investing in large cap US equities is an inferior solution to various other equity asset classes and/or factor strategies.
However, I have begrudgingly committed to SWAN, GDE and NTSX with their collective US large cap equity strategy for one simple reason.
I’m greedy. I want more.
I believe firmly in the strategy of investing in a secondary uncorrelated component (in this case treasuries and gold) with a positive expected rate of return over a long time horizon.
This comes with an added bonus of being in an extended canvas format of 100%+.
Likely this combination will long-term outperform 100% equity factor strategies, such as US small cap value, with greater downside protection.
90/60 stocks/bonds and/or 70/90 stocks/bonds and/or 90/90 stocks/gold, given the historical backtesting I’ve ran through Portfolio Visualizer dating back to the 70s, crushes an S&P only investment in terms of performance and risk adjusted rates of returns.
It’s an irresistible intersection of outperformance meets volatility management.
From a twin-engine analogy US large cap equities and the 10 year treasury have been remarkably resilient duo.
Playing around with PortfolioVisualizer.com reveals that since 1972 US large cap equities and the 10 year treasury have never been down together during the same year!
Oddly enough this could be the year the streak ends as they’re both currently down at -4% and -6% respectively.
Extending that twin-engine analogy to US large cap equities and gold paints a similar picture.
Since 1972, US large cap equities and gold were down together only 4 times: 1981, 1990, 2000 and 2018
Given the uncorrelated results between US large cap equities with both treasury bonds and gold, I’m committed to handcuffing them strategically together with an allocation to extended canvas funds.
What makes me fail to commit to SPD is that I’m merely getting an insurance policy.
Believe you me, as a long-term traveller – and at one time a perpetual nomad – nobody understands the importance of insurance (in this case travel insurance) than I do.
In an alternate universe, where I’m not a stubbornly contrarian investor, a choice between a S&P 500 index versus SPD would be a slam-dunk 100/100 SPD each and every time.
I’d happily swallow at 2% insurance clause in the case that markets are bullish for the downside protection of when they are not.
I’m not interested in the potential of another 2000s scenario lost decade for US large cap equities.
However, given the current menu of ETF options, I’ve got expanded canvas products at my disposal.
What would entice me immediately to consider a fund like SPD would be the additional component of an uncorrelated asset class (with a long-term positive expected rate of return) in addition to the options overlay in an expanded canvas format.
What Would Entice Me Towards SPD ETF
Specifically I’d want this:
A (S&P Equities) + B (Uncorrelated Asset Class) + C (Put Options) = 100%+ Expanded Canvas
For component B, I’d be lukewarm excited about exposure to treasuries and gold (these products already exist) and over the moon giddy about a managed futures program and/or another alternative uncorrelated asset class.
Enormous bonus points would be awarded to the team if Boglehead large-cap market cap weighted equities were replaced with a factor strategy such as minimum volatility (or something else).
I’d pay a higher management fee for that.
The independent research I’ve currently conducted has lead to the creation of my Picture Perfect Portfolio.
This portfolio of equal parts optimized equities, bonds and alternatives (in a multi-strategy expanded canvas format of 180%) has achieved remarkable performance AND volatility management.
13.26% ARR. 20/22 year success rate. -5% worst year.
A big ‘ole slab of cake and giant goblet of wine.
Performance + Volatility Management.
Not one over the other.
Would I love to add an options overlay as an insurance policy to this portfolio?
In a heartbeat.
Diversification is the name of the game.
Diversifying your diversifiers = even better.
SPD = Successful ETF
Given the impressive AUM SPD has accumulated I fully acknowledge the success of this product.
It clearly is a solution that currently works ‘just fine’ as it is for a number of sophisticated investors.
Congratulations to Simplify for its success.
However, I do believe a parallel product that is a bit more aggressive would lure in more investors.
I’ve laid out a few ideas here for its potential enhancement.
A masterpiece creation, in my opinion, would be a multi-strategy diversified diversifier all-in-one product WITH AN insurance policy.
Let’s put it all together now for the in-the-know advisors and the common-folk DIY investors.
What do you think?
Am I asking for too much?
Let me know your thoughts in the comments below.
What do you think of SPD?
Is SPD a part of your portfolio?