For the Equity-Starved, First Trust Is Offering Self-Hedging Funds
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Friday, August 31, 2012

For the Equity-Starved, First Trust Is Offering Self-Hedging Funds

Retail investors are hungry for the potentially higher returns offered by equities and other riskier assets, but are still spooked by the roller coaster volatility.

First Trust [profile] is hoping to tap into this pent-up demand for higher, riskier return by offering more products with built-in hedging capabilities to investors who lack expertise in this area.

"There are a number of retail investors that need to have greater equity exposure in their investment portfolios, they need better returns than they can find in assets such as Treasury bonds," says Ryan Issakainen, ETF strategist and senior vice president at First Trust. "They need to take some risks to achieve their goals, but they are very fearful of investing in equities because of what has happened over the past decade."

Case in point is the newly-launched First Trust CBOE S&P 500 VIX Tail-hedge Fund, an exchange traded fund that invests at least 99 percent of its assets in the S&P 500, with the remaining 1 percent set aside for potential hedging via monthly investments of long positions in a call option on the CBOE Volatility Index (VIX), sometimes called the "Fear Index" of the S&P 500.

The amount invested in this long position will vary depending on where the VIX index goes each month. If the VIX is in the 15-30 score zone, all of the reserve 1 percent will be invested. If the index is between 30 and 50, half of this reserve will be invested. If the index goes above 50, nothing will be put in this long position.

Issakainen said the best analogy for this long position is car insurance: Paying a premium every month for insurance that you hope never pays off, but "when you get into a car accident, that is when you appreciate having it."

The First Trust executive says that his firm is gearing these products primarily to retail investors, because many lack experience in crafting in the kind of the hedging strategies that would help them mitigate the market's current volatility. The firm is looking at a variety of potential hedging tools to build into new funds, ranging from plain old fashioned diversification strategies to more sophisticated and technical approaches.

"These strategies should fit well with retail investors, although there may be some larger institutional investors who may consider them as well," he says. "These will allow investors to gain exposure to equities with some protection from the downdrafts."

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