NTSI - NTSI: Interesting Global Equities Fund With An Overlay Strategy

2023-06-26 21:29:41 ET

Summary

• The WisdomTree International Efficient Core Fund ETF is a global equities exchange-traded fund with a U.S. Treasury bond futures overlay, designed to potentially lower volatility and offer a leveraged profile compared to standard 60/40 portfolios.
• NTSI has underperformed its benchmark, the MSCI EAFE Index, since its inception in 2021 due to large drawdowns in both equity and fixed income markets.
• The fund is expected to outperform in a normalized rates environment within a structural equities bull market, but this is not anticipated in the near term; the author recommends selling and revisiting in early 2024.

Thesis

The WisdomTree International Efficient Core Fund ETF ( NTSI ) is an equities exchange traded fund. The vehicle is fairly new, having come to the market in May 2021. This ETF offers investors exposure to international equities, with a U.S. Treasuries futures overlay. The intention here is to potentially lower volatility via the bond futures and obtain a leveraged profile versus standard 60/40 portfolios. Futures contracts allow a portfolio manager to gain exposure to the Treasury asset class via a small margin deposit, which is typically a fraction of the total value of the contract. This is in contrast to traditional 60/40 portfolios which are all 'cash', meaning the fund buys outright equities and treasuries.

This fund counts the MSCI EAFE Index as its benchmark. As per its literature, the Index:

[...] is designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada. The Index is available for a number of regions, market segments/sizes and covers approximately 85% of the free float-adjusted market capitalization in each of the 21 countries

While its equity composition mirrors the Index, the fund has the Treasury bond futures overlay as an additional portfolio holding. In a normalized economic and rates environment, bonds are supposed to act as a hedge, with equity risk-off moves being accompanied by higher Treasury prices. This has not happened in 2022 when both equities and fixed income had very large drawdowns.

Unsurprisingly, NTSI has underperformed the MSCI EAFE Index since its IPO in May 2021.

Holdings

The fund offers investors a global equities portfolio. The largest weighting in the portfolio is the U.S. (70%), followed by Japan (20%) and the United Kingdom (14%). This exchange traded fund focuses on large capitalization stocks:

The fund is fairly well distributed among the market sectors, given its objective of following the MSCI EAFE Index. From a valuation standpoint its metrics looks good:

The overall P/E ratio for the fund components is low at 14x, and the Price/Sales ratio is also very low at 1.25. As a reminder the S&P 500 Index is currently trading with a P/E ratio in excess of 18x and a Price/Sales ratio above 1.6x.

The interesting part is the bond futures overlay:

While they technically account for a large part of the portfolio, please keep in mind that futures only require a small margin deposit, so it is not the same as having a cash exposure. For example, if we use a straight forward equities set-up, we can have: let's say you want to buy a futures contract on 100 shares of Apple stock. The current price of Apple stock is $100 per share, so the total value of the contract would be $10,000. However, you would only need to post a margin deposit of $500 to open the position. This means that you would be able to control $10,000 worth of Apple stock with only $500 of your own capital. The same applies for Treasuries and Treasury futures. While the resulting mark-to-market impact is very similar to owning the bonds outright, the required cash position to take such a view is different.

Performance

Given its set-up with the inherent leverage via bond futures and the drawdown in treasuries and equities last year, the fund has underperformed:

We are comparing the fund here with the iShares MSCI EAFE ETF ( EFA ), the Vanguard Total World Stock ETF ( VT ) and the iShares Core Growth Allocation ETF ( AOR ).

NTSI is supposed to track the MSCI EAFE Index, hence we see a strong correlation with the ETF that follows the Index. The correlation started to break down after the October 2022 equity market lows.

This year all names have performed in a very narrow range:

When to use NTSI and its build

In our opinion NTSI is set to outperform versus its benchmark and similar funds in the market only in a normalized rates environment. A normalized rates environment is one where equity market sell-offs are accompanied by a move up in Treasury prices. This type of market action would dampen the NTSI drawdown, while its leveraged profile would allow it to outperform during structural bull markets.

Currently we are not there yet. While we think the Fed is done with raising rates, the market is implying another two rate hikes. In a stable or increasing rates environment NTSI will have a cost associated with rolling its bond futures, cost which will eat into its returns. Furthermore, we think we are in a bear market rally, with the second half of the year being a prime time to experience a significant sell-off.

We would only consider NTSI a superior product to the plain vanilla EFA ETF next year when the forward rates curve is showing us lower rates.

Conclusion

NTSI is a global equities exchange traded fund. The vehicle counts the MSCI EAFE Index as its benchmark, but it has a U.S. Treasury bond overlay via futures. Bond futures require very small margins, hence NTSI can obtain a leveraged profile via its construction. The fund has underperformed the index since its inception in 2021 due to the large equity and fixed income markets drawdowns last year. NTSI is set to outperform via its build only in a normalized rates market, where equity sell-offs are accompanied by higher treasury prices. A structural equities bull market with a normalized rates environment will see this fund outperform. We are not there yet, and in our opinion we see another risk-off event in equities this year. Sell here, with the intent to revisit early 2024.

For further details see: