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In my opinion, of the large number of ETFs on the market, only a few qualify as “complete basket”, diversified growth funds.The Risk Parity ETF (RPAR) I talked about recently is perhaps my favorite One, despite a poor performance in 2022. But Amplify BlackSwan Growth & Treasury Core ETF (NYSE:SWAN) must be followed immediately.
Amplify’s leveraged stock and bond strategies remain at fairly low levels: 24% below their November 2021 peak levels. However, the ETF has performed well so far in 2024, as the chart below shows: up 4% year to date and 19% since the bottom in October 2023. Although the two funds have more fundamental similarities than differences, it still far outperforms RPAR.
Consistent with a point I made nearly 12 months ago, I still believe that owning SWAN Today makes sense, and I’ll explain why in more detail below. However, investors should be aware of an issue that could increase short-term risk (i.e., the next three to four months) and could cause SWAN to perform very similar to the S&P 500 itself.
What is a swan?
SWAN is a diversified stock and government bond fund, but an improvement over the traditional 60/40 approach that most of us are very familiar with. These improvements include:
- Rather than allocating more notional value to stocks than bonds like a standard 60/40 strategy, SWAN Risk better balances exposure by focusing more on safer Treasuries rather than stocks.
- SWAN uses leverage to increase a portfolio’s expected return (and risk, mind you) by approximately 1.5 times, making the ETF more suitable for investors looking for long-term growth. So, in practice, SWAN is not a 60/40 stock and bond strategy, but a 60/90 portfolio (60 plus 90 equals 150, which is the leverage factor).
- Finally, SWAN’s exposure to U.S. equities is achieved through a long position in delta-70 S&P 500 (SPY) call options. Doing so allows fund managers to (1) achieve the desired leverage while (2) limiting the maximum possible losses associated with call option premiums associated with equity market risk.
As of this writing, SWAN’s notional investments stand as follows:
DM Martins Research, data from Amplify ETFs
Of course, investing in SWAN is not without significant risks. Although the ETF’s losses related to declines in the S&P 500 are limited (hence the “black swan” reference in the fund’s name), as noted above, these losses can still occur and result in AUM losses of up to 10% or 12%.
Additionally, it might make sense that a fall in Treasury bond prices would cause ETF share prices to fall. In fact, 2022 is the best example yet of how SWAN has been severely damaged by the bond bear market. In 2022, the 10-year Treasury bond lost about 15% of its market value, which may be the largest loss in 100 years, and SWAN fell 27% in the same year.
Why have SWAN (and what are the benefits)?
Having SWAN makes sense to me for the same reasons as RPAR. So I could simply copy and paste my bullish view on risk parity ETFs, and I’d probably capture the bulk of the SWAN bullish case. A quick recap:
- I believe that a leveraged three-part Treasury, two-part stock portfolio could produce significantly better risk-adjusted (and perhaps even absolute) returns over a long period of time than the S&P 500. This strategy is more balanced and positioned to generate higher returns during economic downturns.
- SWAN and its cousin RPAR took a huge hit in 2022 due to their exposure to Treasuries, which in turn took their worst hit in a century due to rapidly rising interest rates. But when it comes to bonds, pain in the rearview mirror usually means profits are looking through the windshield, as future returns are roughly equal to the yields on those bonds when they were purchased (i.e., the 10-year today is about 4.0% , while the 10-year bond is about 4.0%). Only 0.5% around mid-2020).
- Considering a steady-state risk-free rate of 3%, an equity risk premium of 5.5%, and a Treasury yield of 4%, I think a 1.5x leveraged fund like SWAN should generate about 8% per year over time. Discounted SPY call option’s hedging cost. In my opinion, this is quite compelling for a diversification strategy.
The problem is that SWAN may become more unstable in the coming months. The fund currently holds two batches of SPY call options, with deltas of 0.86 and 0.97 respectively, well above the target delta of 0.70. This is so because the portfolio is only rebalanced every six months (the next one will happen in June).
Since the last rebalancing, the S&P 500 has climbed significantly: up 7% year to date and 26% over the past 12 months. This is why SWAN’s notional exposure to the S&P 500 is currently 86% (as shown in the chart above), rather than 60% as one would expect. This could also go a long way in explaining why SWAN has performed much better than RPAR so far in 2024, despite fairly similar strategies.
So, keep in mind: SWAN is likely to perform more like the S&P 500 for the foreseeable future because (1) equity exposure is currently higher, and (2) option delta is higher, meaning the S&P A $1 change in the 500 Index would have an impact of nearly $1 on SWAN.
This may increase short-term investment risk, but does not change my long-term bullish stance on SWAN.
