ETF Expert Corner
REX Shares Founder & CEO Explains Gold Hedged ETFs
July 19th, 2016 by ETF Store Staff
Greg King, Founder & CEO of REX Shares, spotlights the REX Gold Hedged S&P 500 ETF (GHS) and the REX Gold Hedged FTSE Emerging Markets ETF (GHE).
You can listen to our interview with Greg King by using the above media player or enjoy a full transcription of the interview below.
Nate Geraci: We are spotlighting two ETFs this week, the REX Gold Hedge S&P 500 ETF, ticker symbol GHS, and the REX Gold Hedged FTSE Emerging Markets ETF, ticker GHE. Joining us via phone from West Port Connecticut to discuss these ETFs is the Founder and CEO of REX Shares, Greg King. Greg, a pleasure to have you on the program today.
Greg King: Nate, it's great to be here, thanks.
Nate Geraci: Greg, before we get to these two ETFs, tell us a little bit about REX Shares and perhaps how you became involved in ETFs.
Greg King: REX Shares is a new ETF company. We just started up last year, but the team is actually ETF veterans. My own start in the business came about 12 years ago working with iShares. I was actually with Barclays Capital, the investment banking side, and we partnered with our sister company, iShares starting in 2004 to create a product line that targeted commodity based ETPs. That product line, iPath, came to dominate the scene early on. I really got my start there in 2004, 2005. Since then, I founded another company called VelocityShares focused on commodities and volatility products, and have also worked with Global X and Credit Suisse on their exchange traded product platforms. As I mentioned, we started REX about a year ago. The idea was really to take the background of the team and focus on creating products that are more efficient and enhance investor performance. As you mentioned, we have a lot of ETFs out there. Investors have a lot of choices. Our background is on the technical, product structuring technical. Which is pretty boring stuff to most people but it can make a difference ultimately in investor performance. We've tried to take that expertise and focus on rather than kind of new approaches to investing, really just taking a look at existing investments and seeing if there is a way to structure them more efficiently so that investors can get a more effective exposure in their portfolio, or drive some efficiencies in this day of low interest rates.
Nate Geraci: So the first ETF we are going to look at today is the REX Gold Hedged S&P 500 ETF. Again, ticker symbol GHS. This couples the returns of the S&P 500 and gold futures contracts. Explain to us what this means and how this ETF works.
Greg King: GHS really came from talking to advisors who liked the idea of owning gold, but had a couple of issues with it. We all know that gold ETFs have been around, the physically backed, the bullion based ETFs have been around for over 10 years now. But a lot of people said, look, with gold, it's kind of one of those things like insurance. You need it when you need it, but otherwise it kind of just sits there in a portfolio. Holding a gold allocation on a permanent basis to a lot of advisors just felt like paying away premiums that they didn't really want to. They have this kind of love hate. On the positive side, the risk reward metrics of gold in a portfolio really shine as we all know. Gold is a diversifier. So GHS, what it does is it says, look, S&P 500 is something that is very common in portfolios, futures are available on gold because gold is a commodity. Why not take exposure to gold via the futures market? What this does is it allows the investor to utilize an existing position in their portfolio to effectively put up as collateral for that gold exposure. If you take a step back, a bullion type of holding really requires cash available in the portfolio to purchase it. Our view is that works for a lot of investors and that's fine, other people want to be perhaps a bit more conservative with their capital and keeping the S&P 500 holding, for example, that they already have might appeal to them over the long term. GHS allows investors to kind of keep their long term equity allocation but take exposure to gold into the portfolio at the same time.
Nate Geraci: Greg, you know currency hedging has been a popular topic over the past several years and as we talk about this particular ETF, the mechanics seem very similar to currency hedged ETFs, but instead of hedging a decline in the Yen or the Euro, you are hedging against the decline in the dollar versus gold. Is that a good way to think about this ETF?
Greg King: Yeah, that's a great way actually. Investors in the US don't tend to think about their currency exposure quite as much as offshore, but that is definitely a way to look at this. The dollar depreciating against gold. Remember gold is priced in dollars, right? Sort of by definition, if gold prices are going up, it means the dollar is going down versus gold. Does that mean that the dollar is going down versus the rest of the world currencies? There does tend to be a correlation. It's not a one to one, but generally speaking there is a correlation between rising gold ... Or depreciating dollar versus gold, and depreciating dollar versus other currencies. When we talk to investors about that particular aspect, they are really focused on the environment of money printing that we are in and what's going to happen when this sort of tidal wave of monetary policy comes home to roost. For the time being, the US dollar has been a safe haven, but people are looking ahead and down the road, what's coming next.
Nate Geraci: Simply put, is the goal of this ETF ultimately to outperform the S&P 500? Assuming the value of gold increases.
Greg King: Yeah, that is basically the goal of the product. From a long term perspective, we know that gold was de-pegged from the dollar back in the early 70s. It was at $35 an ounce at that point. Clearly we are well over $1,000 now. We touched up to $1,900 as most of you know. Long term, gold has been up over those 45 years about 8% per annum on average. It's got big fluctuations, but the question is really for a long term asset allocation strategy, is gold a viable long term investment? We think it is, and we think that this way is an effective way to hold it within the portfolio.
Nate Geraci: Again, we are visiting with Greg King, founder and CEO of REX Shares. Greg, I guess sort of on that note, some investors might look at this ETF and say, I have to get two bets right. Both the S&P 500 and gold. They might express some concern that perhaps both of these move in the wrong direction at the same time. How should investors think about the risks of a gold hedged S&P 500 ETF?
Greg King: There are risks of course. You've got basically a dollar doing the job of two dollars. In this fund, the way it's constructed is the fund owns a basket of S&P 500 stock. There, you are effectively long a similar exposure to the S&P 500. Then over the top of that, you have a gold future for the entire notional of the fund that gets re-balanced periodically. You do have one dollar exposure to gold plus one dollar exposure to S&P. You are right, if both of those go down simultaneously, that would accelerate losses. Now, the beauty of this is that generally speaking gold has a zero-ish correlation to equity markets. Sometimes a little bit positive, sometimes a little bit negative, but over the long term, both have experienced positive returns over several decades. This type of a reason is why we call it a gold hedged exposure, because you are using the gold to sort of hedge the S&P return. Obviously it's not a perfect hedge, but they can zig and zag at different times and that can benefit the investor. The people who are worried about the risks, absolutely it does potentially increase the volatility of the portfolio, but it also historically at least would have increased the risk reward ratio. The increase in volatility would be less than the increase in the return.
Nate Geraci: What about the costs of the gold hedge? We know in investing of course there is a cost for everything. With currency hedged, Euro or Yen ETFs, because interest rates are so low, the cost of currency hedging has been minimal. What about here? What are the costs of gold hedging?
Greg King: Great question actually. Gold futures are very efficient, very liquid market. There are costs associated with it, which really have to do with the idea of arbitrage as with most futures markets. When you think about a physical commodity like oil or something like that, it gets complicated because there can be supply shortages and shocks and things like that. With gold being a financial asset, it's a little more predictable and the commodity curve is a bit more stable. The cost associated with financing gold that are embedded into the futures position, they can vary anywhere from just very low single digit basis points up to 50, 75, even 100 basis points on an annualized basis. But you got to compare that against what it costs to physically own gold and store it and the charges associated with that. We tend to think of it in terms of a number that more or less resembles libor.
Nate Geraci: Lastly, before we move on here, where does GHS fit in the investor’s portfolio? Is the idea to use this as a replacement for traditional large cap US exposure? Is this a compliment?
Greg King: We've talked to a lot of investors who were actually considering it that way. You brought up currency hedged earlier and I think that's a great comparison. If gold was still the currency of any developed nation, then this would be considered a currency hedged product. But it's not. The similarities are there though, the structure is very similar. Large cap equity is typically where people hold this in their portfolios. They view this as a hedged equity type of position, but we have spoken to others who view it more as an alternative investment.
Nate Geraci: Again, we are visiting with Greg King, founder and CEO of REX Shares. Greg, REX also offers a gold hedged emerging markets ETF, ticker symbol GHE. I assume this works the same way as the S&P 500 ETF only this one holds emerging markets stocks. Is that correct?
Greg King: It does actually, and because there are so many emerging market stocks, our fund actually chose to hold the Vanguard ETF in order to get its exposure. We rebate those fees back to the fund, so investors are flat, but that's a more efficient way to do it rather than assemble this huge basket of emerging markets stocks. But otherwise, the mechanism is the same with the gold overlay providing an addition gold exposure over the entire portfolio. Again, the concept is a dollar of investment in this product would be getting you long, emerging markets and long gold doing two dollars’ worth of work. But there is an interesting angle here in the sense that emerging market currencies are not easily hedgeable. Gold has been shown, The World Gold Council did a research paper, to be a pretty decent proxy hedge for emerging market currencies. As we know, part of the issue with hedging EM currency is really the cost. You have 600, 700, 800 basis points of interest rate differentials often. That type of headwind going into the year, investors are really hesitant to put those kinds of hedges on starting that far behind the line. With a gold hedged EM product, we thought this could be a potential solution for that issue. Going back to the currency hedged ETFs, the ones that were really successful were developed markets. The currency hedged emerging market products really haven't taken off, and we think that's in large part because of the cost of EM hedging.
Nate Geraci: Greg, you touched on this a bit earlier, but I think this is an important point to reiterate as it relates to both of these gold hedged ETFs. Why not just own a physical gold ETF in a portfolio if you think gold is going to perform well? Why own gold through a gold hedged stock ETF?
Greg King: Great question. I think there are really three reasons. Number one is capital efficiency. We see a lot of advisors saying, well, we need to find yield, we need to generate income in the portfolio. To the extent that advisors or investors already have equity exposure and gold exposure. Our funds allow them to consolidate those and to free up cash in the portfolio that could be used elsewhere. The second is just a hedging concept. People may have emerging markets or they may have large cap equity exposure that they would like to put some kind of a hedge around. Gold can contribute to stabilizing that type of exposure in certain environments. Then the third reason is really a market timing related reason. Gold is one of those asset classes that people love to own when the time is right and then don't so much care to own when nothing is going on. Q1 in 2016 is a great example, that was the best quarter in something like 30 years. A lot of investors just missed it, they just clean missed it. You have a market timing question always happening with gold. When do I get in, when do I get out? We feel that our gold hedged equity funds allow investors to kind of take that question off the table and have some portion of their portfolio permanently allocated to gold and kind of running in the background. They do have a position there when the market decides that gold is really going to rally.
Nate Geraci: We have just a few minutes left here. Obviously your two ETFs cover broad asset classes. But given the innovative nature of these ETFs, I thought I might ask you about a topic we covered on our show last week, which is whether ETF innovation has gotten out of hand. I'm not sure if you saw the recent comments from Vanguard CEO Bill McNabb where he expressed concern about some of the new ETFs coming to market. Now, Conor and I made the point that there are over 8,000 mutual funds, and 24,000 when you consider all the different share classes. Of course, there are only some 1,900 ETFs. We think this concern is a little bit misguided. But I'm just curious, what are your thoughts on ETF proliferation?
Greg King: That's a great question. I don't think it's gotten out of hand. I think that if you knew what it took to get an ETF to market, which I'm sure you do, your listeners might not be as familiar, there are a lot of safeguards in place, there are a lot of approvals required. There are a lot of government agencies that we need to work with. I'm of the belief that innovation is a good thing in financial markets. I'm also of the belief that education is important. What you guys are doing to educate advisors and investors is a very good thing. So long as the innovation has some safeguards and checks, which are definitely there, we are all for it and we think that there is more to come. I think the number of ETFs is somewhere around just under 2,000 in the US, and yeah, there are a lot more mutual funds than that. It seems like we are still going strong.
Nate Geraci: Well Greg, with that, we'll have to leave it there. Congratulations on the launch of these two gold hedged ETFs, and we certainly wish you the best of luck moving forward, thank you.
Greg King: Thank you so much Nate, great to be here.
Nate Geraci: That was Greg King, founder and CEO of REX Shares. The ETFs are the Gold Hedged S&P 500 ETF and the Gold Hedged FTSE Emerging Markets ETF. You can learn more about both of those ETFs by visiting REXetf.com.