How Does VolDex Stack Up to the VIX?
(Nov 2013)
We've talked a lot about the idea of using volatility to hedge equity exposure. The basic finding, from our research work and that of others, is that the CBOE Volatility Index (VIX) hedges the S&P 500 fairly well. Unfortunately, the VIX is not investable, but is a complicated calculation based on a large strip of options contracts -- i.e., contracts of varying moneyness. Proxies for the VIX, such as rolling VIX futures strategies, are much worse hedges and have a number of problems that make...
Just How Risky Are Leveraged and Inverse ETFs?
(Oct 2013)
Leveraged and inverse exchange-traded funds (ETFs) are some of the most volatile securities traded in public markets. They are designed to track a specific index, except multiplying daily return of the index by a positive (leveraged) or negative (inverse leveraged) factor. The 'daily' part is important: leveraged and inverse ETFs do not track the leveraged or inverse return of the index for any period longer than a single day due to portfolio rebalancing. You can find more details about...
Do Leveraged ETFs Increase Stock Market Volatility?
(Aug 2013)
Leveraged exchange-traded funds (LETFs) are controversial investments. Because they can be leveraged as much as 3x, and can be linked to highly volatile underlying assets, their daily price movement is typically very dramatic. Also, LETFs tend to lose value over time if their underlying assets are relatively volatile due to rebalancing effects, something we've covered in our blog post "Leveraged ETFs", as well as in our research papers, "Leveraged ETFs, Holding Periods
and Investment...
Are ETF Flows Costly to ETF Investors?
(Apr 2013)
Exchange-traded funds (ETFs) are often lauded for their ability to efficiently create or redeem shares in response to changes in demand for the fund (known as fund flows). However, new research suggests that some ETFs that hold international securities may face transactional frictions that prevent them from tracking their benchmarks as well as other ETFs.
When there is an imbalance between supply and demand for an ETF, authorized participants (APs) create or redeem shares of the ETF to...
Derivatives in Active ETFs
(Dec 2012)
Over two and a half years ago, the SEC initiated a moratorium on approvals for new ETFs that made extensive use of derivatives such as options and futures contracts. Much of the concern at that time was that derivatives-based ETFs, particularly leveraged, inverse, and futures-based ETFs may not have investor protections or oversight commensurate with their level of risk. Regular readers of this blog know that we have spent a good deal of time discussing those issues in addition to our ...
Do Leveraged ETFs Contribute to Share Price Volatility?
(Nov 2012)
We've talked a lot about leveraged and inverse Exchange Traded Funds (LETFs)and the problems that can arise from their rebalancing. A recent paper from a group at York University asks two simple but interesting questions: does this rebalancing affect the volatility of the underlying assets? If so, can a sophisticated trader exploit that effect to achieve excess returns?
On the first question, the authors find two main results. First, the directional trades LETF providers and counterparties...
Mutual Funds Holding Leveraged and Inverse Leveraged ETFs
(Oct 2012)
While looking through recent SEC filings, an updated prospectus happened to catch our eye. The prospectus offers updated information concerning the investment strategy and details of two mutual funds: USFS Funds Limited Duration Government Fund (USLDX) and USFS Funds Tactical Asset Allocation Fund (USFSX).
The fund management company -- Pennant Management, Inc. -- states in this prospectus that "[USFSX] may invest up to 33% of its assets in leveraged ETFs and inverse ETFs, up to 10% of its...
Time to Call for More Transparency in ETF Market
(Mar 2012)
Exchange-traded funds (ETFs) started as a "plain vanilla" product: a type of low-fee, tax-efficient mutual funds holding index-mimicking portfolios. The first ETF was formed by the Toronto Stock Exchange in the 1980s and has garnered spectacular popularity in recent years. According to a recent article in The Economist, the number of ETFs in America has almost tripled from its 2006 level of 343 to 1,098 in December 2011. This volume increase has been accompanied by substantial financial...
