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ETNs to Avoid a Full Bear Market Decline

NEW YORK ( TheStreet) -- In the last month or so, Royal Bank of Scotland (RBS) jumped into the exchange-traded products market with two ETNs and with plans for more funds relatively soon.

The two new funds are the RBS US Large Cap Trendpilot ETN (TRND) and the RBS US Mid Cap Trendpilot ETN (TRNM). The two funds employ the same trend-following strategy but for different indices with the general idea of providing long index exposure when the index is above its 200-day moving average, and providing Treasury price exposure when the stock index is below its 200 DMA. Neither fund will pay interest.

More specifically, the large-cap Trendpilot will replicate the S&P 500 when that index is above its 200 DMA and switch to replicating T-bills five consecutive days after the index breaches its 200 DMA. It will go back to equity replication when the index goes back above the 200 DMA for five consecutive days. The mid-cap Trendpilot will do the same thing for the S&P 400 index, which is a standard mid-cap benchmark. Both funds will charge 1% when they are in equity mode, and 0.5% when they are in Treasury bill mode.

Heeding the 200 DMA as a trigger point for defensive action is what I do for my clients, so I buy into the concept wholeheartedly. In a normal diversified portfolio, going out of equities completely in this type of scenario is not very practical due to tax reasons and the brokerage commissions that would need to be paid. However, the Trendpilot funds avoid both. In a taxable account there is no tax consequence for strategy shifts within the ETNs. There would be a reportable gain or loss upon selling the funds, of course.

The aim of this strategy is to avoid the full brunt of a large bear market decline. Crossovers don't occur at the very top; they occur, in a bear market context, after a gradual rollover in the broad index. The breach that occurred in late 2007 was very characteristic of what this looks like and anyone heeding that warning (I blogged about this on Dec. 13, 2007) avoided a lot anguish over the next 17 months.

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