Cashing In The Deflation ETF Portfolio

In the September issue of Canadian MoneySaver I updated an ETF portfolio that was designed to benefit from a deflationary trend. I was concerned that interest rates were rising despite the attempts of central banks to keep rates low. I concluded that the portfolio was still valid for the time being. The portfolio just turned four years old on Dec 8, 2013 and performed as follows versus the benchmark indices:

What I find interesting is that during the most inflationary monetary policy in modern history, gold performed the worst out of the group. The big winner was the US stock market where most of the monetary stimulus gravitated during the period. At this point I would rather remain in the deflationary ETF portfolio than the above alternatives, however I don’t think this is the best strategy at this time. What bothers me is the possibility of a credit contraction deflationary event. This is a scenario where few can borrow and banks are unable or unwilling to lend. I will outline this viewpoint in future articles but for now I consider a cash portfolio to be ideal while we wait for a normal and natural correction to occur.

I will be discussing a new portfolio for 2014 (and beyond) that will be designed to provide investors with a similar amount (hopefully more) income than the current 3.9% yield on the deflationary ETF portfolio. The idea is to keep 80 to 85% of your portfolio in cash and invest the remainder in long term options based on the S&P 500 Index. I will track both a bull and bear portfolio as well as a neutral portfolio that takes no direction bias.  Currently, the long term options expiring on Dec 19, 2015 are priced so low that the S&P 500 index only has to drop by 8% or gain 5% for these options to break even. The market has historically experienced major advances (like last year’s 25%+ gain) and declines that exceed 10% over many two-year periods. The advantage of this trade will be to reduce your exposure to the market by 80% while still generating similar upside based on your view of the market. The income portion will be generated  by writing short term options against these long term positions at regular monthly intervals. The options will be at or slightly out of the money to generate the most current income. I expec

t the option income will fluctuate widely during the period and is completely unpredictable.  Based on current option premiums, the one month at the money options will generate 1.2% of the value of the S&P 500 Index. I will be tracking this income generated using this strategy and incorporating it in the total return of the portfolio.

My expectation is that both the bull and bear portfolio will outperform the actual S&P 500 index over the twoyear period with muchlower risk and generate a much higher income than the current 1.9% yield of the index. I started the new portfolio/index on January 1, 2014 and will let you know how the portfolios are doing in a later issue.

Derek Gates, CFA, CFP, FCSI Sustainable Wealth Management 

Ltd. Author of the Canadian Oil Sands Investors’Guide.

The Sustainable Oil Sands Index is published by the author and is the index of iShares Oil Sands Sector ETF.