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Trade Alert

August 25, 2023

One of the ETF holdings in our Conservative portfolio, the NightShares 2000 ETF (NIVM), was liquidated last week. For now, we're shifting the 5% allocation to cash via an ETF specializing in 6-month T-bills. This means we're transitioning from a no-yield cash position to an actual cash-like fund with a much higher yield (5.19% 30-day SEC Yield / 5.39% Yield to Maturity) and low fees. We believe this is a move everyone at a brokerage firm should consider for their cash holdings. Vanguard stands out as the only major brokerage platform offering a solid money market fund sweep option, with Fidelity following closely. For others, trading into a cash-like fund is necessary, especially since the cash sweep accounts remain at sub 1% yield, which was acceptable when rates were near 0%. A sweep account is where cash is held between trades.

With risk-free yields now soaring above 5%, courtesy of the Federal Reserve's ongoing anti-inflationary measures, short-term treasuries or T-bills provide an almost risk-free opportunity. This yield is notably higher than the 100-year historical T-bill average return of around 3.5% and an inflation rate of approximately 3%. Moreover, these returns are significantly above the trailing 20-year averages, which are around 1.3% for T-Bills and 2.5% for inflation.

Our choice is the relatively new BondBloxx Bloomberg Six Month Target Duration US Treasury ETF (XHLF), which focuses on 6-month treasury bills. This fund has a minimal 0.03% fee and yields over 5%. It might slightly lag behind other shorter-term T-bill funds if rates keep rising. We believe such rate hikes will soon stop then settle into a historically high plateau until something breaks in the markets, real estate, or economy.

Another option is the iShares® 0-3 Month Treasury Bond ETF (SGOV), although its annual fee could rise from the current 0.07% to 0.13% next year once the fee reimbursement expires. Unlike SGOV, BondBloxx doesn't employ temporary introductory fees. Generally, these funds should outperform most house money market funds on brokerage platforms. The WisdomTree Floating Rate Treasury Fund (USFR) and the iShares Treasury Floating Rate Bond ETF (TFLO) are also worth noting. Though they have a higher fee of 0.15%, the returns on floating rate notes (FRN) might justify the cost, especially since FRNs typically offer a slight premium over short-term T-Bill rates. Also note the above funds are state tax free as the income is essentially 100% from the treasury.

In our client accounts, we do incorporate some direct T-Bill and FRN purchases. However, for the majority of situations, these above funds prove invaluable. Any minor fee concerns associated with these funds pale in comparison to the significant lost opportunities presented by bank or brokerage cash accounts in today's climate. It's crucial not to settle for sub 1% returns in a world yielding 5%, even if your bank or broker might prefer you to do so in order to offset their own loan losses from rising rates.

While these funds resemble almost risk-free cash-like instruments, short-term treasury funds such as the Schwab Short-Term US Treasury ETF (SCHO) can experience slight fluctuations with rapid rate rises. However, they might outperform lower maturity cash funds if rates start declining rapidly.

We're also rebalancing some holdings, as stocks have recently outperformed while bonds have lagged, with long-term rates revisiting their 2022 highs. For instance, if a stock fund's allocation increases from 10% to 12% and a bond fund decreases from 10% to 8%, we're making adjustments. In the case of our Vanguard Extended Duration Treasury ETF (EDV), we're making substantial purchases, implying our rebalanced portfolio will bear more interest rate risk in the near future. If rates rise further, we might pivot more towards bonds, especially if stocks continue their current upward trend.

Specifics about the liquidated fund:

The NightShares 2000 ETF (NIVM), which was recently liquidated by its sponsor, was based on the historical observation that stocks typically secure most of their gains overnight. The strategy was to buy stock index futures at market close and sell them the next morning, remaining in cash during the day. Unfortunately, this approach was less than successful.

We had initially reviewed this pattern over a 20-year span with our own research and found it promising, especially during bear markets. The potential downside was also less pronounced than with traditional stock indices.

However, the fund disappointed on multiple fronts. Our Conservative portfolio saw an investment of $5,908.82 on 06/30/22 or $29.99 a share, yielding a return of only $5,512.15 upon its liquidation on 8/15/23. This near 7% negative return was a letdown. Small-cap stocks like the Russell 2000 did underperform the S&P500 by about 7%, but this doesn't explain the fund's subpar performance as both small and large cap were up during this time frame.

NIVM's downfall can likely be attributed to two main challenges. Over much of the last year, the trend has shifted: buying the market in the morning and selling in the evening has produced similar results to holding onto the Russell 2000, but with less volatility. This night trading strategy failed to offer the expected rewards, though this has happened historically as well. Moreover, the fund seemed unable to effectively replicate even this modest night return, indicating implementation issues. Spotting a historical pattern is one thing, but real-world application, with all its inherent costs, is another.

In hindsight, shorting this fund while going long on the Russell 2000 would've yielded better results. However, in recent weeks, the pattern of nights outperforming days seems to be making a comeback, although it's uncertain if the fund would have capitalized on this trend if it remained active.