New ETFs only invest at night and aim for dreamy returns

Financial advisers are always talking about building portfolios for clients that allow them to sleep at night. Well, now there’s an investment strategy that might allow clients to sleep at night because it does its best work at night.

Or at least that’s the plan.

Two new actively managed ETFs from Corte Madera, California-based NightShares are being promoted at “capturing the night” by buying index exposure at the end of each trading day and selling it when the markets reopen in the morning.

The NightShares 500 ETF (NSPY) and NightShares 2000 ETF (NIWM) started trading last week with the unique strategy of tracking the after-hours performance of their respective indexes, the S&P 500 and the Russell 2000.

It’s too soon to know whether the bet on after-hours activity, when there tends to be less retail-investor noise, will appeal to financial advisers and other ETF investors. But the premise is logical, and the back-tested performance is curiously impressive.

“Just when you think the ETF industry is out of new ideas, here comes something like this,” said Eric Balchunas, ETF analyst at Bloomberg Intelligence. “It’s almost introducing a new way of doing things.”

Balchunas put the strategy in the broader group of factor investing techniques, with nighttime being the factor.

“The back tests look good and it’s not just them doing the back testing,” he added. “The numbers will have to be there, but if this can take off, they have a lot of room to expand the product lineup.”

Max Gokham, chief investment officer at NightShares sister company AlphaTrAI, said the night trading strategy has long been used by the AlphaTrAI hedge fund as a way to diversify into lower-risk market exposure.

“During the daytime, equities tend to be riskier than they are at night,” he said. “We saw that a lot of academics had written about it, but mostly about how it works with large-cap stocks.”

On a back-tested basis, AlphaTrAI data show the Russell 2000 Index generated a cumulative return of 262% from 2012 through March 2022, but during official trading hours was down 26%.

Nate Geraci, president of The ETF Store, said the idea of trying to capture the “night effect has long been discussed and debated.”

“Now that these products are actually out in the wild, it will be absolutely fascinating to track their performance,” he added. “The key question is whether any outperformance generated by only having exposure to markets at night is eaten up by high transaction costs. I expect these ETFs to initially find an audience, but their longer-term viability will be driven by whether they can deliver dreamlike performance.”

With a strategy scheduled to move in and out of the market each trading day, NightShares Chief Executive Bruce Lavine acknowledged that trading costs are no small factor.

“Trading costs are always something you have to factor in,” he said. “But we think they’ll be quite manageable in the long run.” Those trading costs are part of the reason the ETFs are charging 55 basis points, which Lavine said could go down over time.

Todd Rosenbluth, head of research at VettaFi, said there's logic behind the idea of a capitalizing on news and events that happen when markets are closed.

“While a lot of macroeconomic data and company-specific earnings data is released when the stock market is closed, the after-hours trading stock market is relatively illiquid compared to traditional hours,” he said. “These new ETFs can be used to gain access to this arena. Advisers could pair these with traditional equity ETFs to reduce market volatility.”

Bloomberg Intelligence's Balchunas also sees the new ETFs offering diversification, as opposed to a bigger portfolio bet.

“It could be used almost like an alternative investment,” he said. “If you look at numbers, holding at night clearly outperforms just holding during the day, but holding the whole time crushes both.”