Black swan events are impactful and unpredictable. The Amplify BlackSwan Growth & Treasury Core ETF (SWAN) was designed to protect against them. Let’s dive into it.
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Contents
What Is a Black Swan Event?
The term black swan is used to describe an extremely rare, inherently unpredictable event that has severe negative consequences. It has also been noted that hindsight bias is unusually common with black swan events, with people later claiming the event should have been obvious at the time. Notable examples of black swan events include the Dotcom crash of 2000, the 2008 financial crisis, and the recent pandemic in 2020.
The idea of black swans was proposed by famed professor, author, and former trader Nassim Taleb. He has written several popular books on the concept of black swans and human beliefs related to risk and the asymmetry thereof. Taleb asserts that because of the inherent unpredictability and significant impact of black swan events, investors – and people in general – should remember that they are possible and should plan accordingly.
Enter the SWAN ETF
The BlackSwan ETF from Amplify was designed to do just that – protect against these unpredictable, adverse events. Appropriately, its ticker is SWAN. The fund, which launched in 2018, is designed to be a relatively safe, conservative investment vehicle that is still able to capture some upside while being more concerned with protecting the downside. Roughly 90% of the fund is invested in intermediate U.S. treasury bonds, with the other 10% in long-dated call options (LEAPS) on the S&P 500 (specifically, the SPY ETF) that target 70% participation (i.e. option delta of 70). In this sense, the fund’s target notional exposure can be described as 70/90 stocks/bonds. The fund’s proprietary index is the S-Network BlackSwan Core Total Return Index, which is rebalanced and reconstituted on a semi-annual basis.
Just like NTSX, the classic 60/40 Portfolio, and the famous Hedgefundie Adventure strategy, SWAN relies on the uncorrelation between stocks and treasury bonds, which tends to be conveniently amplified during periods of market turmoil, as treasury bonds are the best diversifier (i.e. lowest correlation) for stocks. This diversification takes advantage of the flight to safety behavior that causes investors to rush into treasury bonds when the stock market is crashing. Interestingly, unlike other defensive funds that use active management to attempt (unsuccessfully) to time the market, SWAN doesn’t change its asset allocation and doesn’t limit upside gains in order to provide its defense. We would expect it to lag the market in bull markets, but it is still able to participate in them.
This fund reminds me of and is similar to NTSX from WisdomTree, but whereas NTSX is built for stock market participation with a secondary goal of downside protection, SWAN was built for the opposite – downside protection as the primary goal, with market participation being secondary. An intrinsic feature of SWAN’s LEAPS on SPY is that its call option exposure grows as the stock market rises, and shrinks as the market falls. This means the fund participates increasingly more in stock market success and naturally gets more protective as the market drops. Note that SWAN should be less tax-efficient than NTSX.
The SWAN ETF’s Historical Performance
SWAN has definitely delivered on its promise in its short lifespan thus far. When the market fell roughly 17% in the Q4 2018 correction, SWAN fell only about 4%. When the market dropped by 30% in the crash in March, 2020, SWAN dropped by 8%. Here’s a backtest going back to SWAN’s inception in December 2018, through June, 2021:
As we’d expect, SWAN has lagged the market in terms of total return but has delivered a much higher risk-adjusted return. Notice its volatility is less than half that of the S&P 500, and its max drawdown during this time period was 1/4 that of the market.
While we can’t backtest options, we can get a rough idea of how SWAN might have behaved prior to its inception using its target nominal exposure of 70/90 using the S&P 500 and intermediate treasury bonds. I’ve compared it to NTSX and the S&P 500 below going back to 1991, during which period these funds would have provided returns above that of the market but with lower volatility and risk:
Keep in mind this period was a great time for bonds, which helped result in the market outperformance.
So we know SWAN is for de-risking the portfolio and for protecting against black swan events. Let’s briefly talk about a way to do that further.
As I’ve noted many times elsewhere, I’m not a big fan of gold, but there are a couple things it does do: reduces portfolio volatility and risk due to its usual uncorrelation to both stocks and bonds, and hedges against uncertainty. A perfect descriptor of a black swan event is uncertainty. And since the SWAN investor is likely more concerned with the portfolio’s volatility and risk than its returns, I’d argue this is one of those instances where the addition of gold may make sense.
Let’s look at how it would have played out historically for SWAN if we set it at 80% and add 20% gold, again from 1991 through June, 2021:
Notice how we would have sacrificed a bit of CAGR for 11% lower volatility and, arguably more importantly, a 25% smaller max drawdown. Risk-adjusted return (Sharpe) also came out slightly higher. So as usual, it comes down to how far you want to slide on that scale of risk and expected return.
I’ve created that 80/20 SWAN/gold pie here for anyone interested.
Conclusion, and Where To Buy SWAN
In my opinion, SWAN looks attractive for a risk-averse investor looking to protect against drawdowns but still get some market participation so as not to miss out on any potential upside. It is also appropriate for those at or nearing retirement, for whom market crashes are more detrimental. This fund is one that doesn’t seem to care too much about volatility per se but instead focuses on drawdowns and navigating them unscathed, which it has demonstrated it can do effectively. Adding a dash of gold may improve that effort even more.
SWAN provides what I’m a fan of: leveraged exposure to uncorrelated assets. Funds like SWAN make it more likely that the investor will stick with their strategy and “stay the course” through market turmoil, and I’m always trying to encourage that.
SWAN’s fee of 0.49% is obviously high compared to simply broad index funds from Vanguard like VTI, for example, but is actually on par with others for this type of option rolling strategy. You can choose to buy these same assets and roll the LEAPS yourself, or pay 49 basis points for the convenience of having someone else do it for you. In January, 2021, Amplify launched an international version, for which the ticker is ISWN, which may be a good addition for diversification considering SWAN only uses U.S. stocks. However, it’s only amassed about $30 million so far.
At this point, SWAN should be available at any major broker. My choice is M1 Finance. The broker has zero trade commissions and zero account fees, and offers fractional shares, dynamic rebalancing, and a modern, user-friendly interface and mobile app. I wrote a comprehensive review of M1 Finance here.
What do you think of SWAN? Let me know in the comments.
Disclosure: I own NTSX.
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Disclaimer: While I love diving into investing-related data and playing around with backtests, I am in no way a certified expert. I have no formal financial education. I am not a financial advisor, portfolio manager, or accountant. This is not financial advice, investing advice, or tax advice. The information on this website is for informational and recreational purposes only. Investment products discussed (ETFs, mutual funds, etc.) are for illustrative purposes only. It is not a recommendation to buy, sell, or otherwise transact in any of the products mentioned. Do your own due diligence. Past performance does not guarantee future returns. Read my lengthier disclaimer here.
Some things worth noting:
It seems that (unlike NTSX) SWAN isn’t very tax efficient. It keeps all the interest from Treasuries as ordinary income, and turns some qualified dividends and LTCG into ordinary income.
Additionally, I recall the bogleheads forum discussing this fund in March 2020 and determining that one thing to potentially be wary of is the current holdings at the time of purchase. At that time it had only 1% S&P options contracts and 99% Treasuries. That’s a little scary to buy into to say the least and emphasizes the riskiness of this fund imo.
Not something I’d own, but it’s an interesting fund to wrap one’s head around.
Replying to myself to note that I looked into the fund more and find it interesting. It’s certainly worth consideration for a loss-averse investor.