Schaeffer's Trading Floor Blog

Word of Warning: New ETFs for Sale

Two new ETFs traders should avoid

by 7/8/2013 7:38 AM
Stocks quoted in this article:

While you were out grilling some burgers, at the beach, or simply ignoring the markets, guess what you missed? More volatility ETFs, courtesy of VelocityShares. Yes, that's the same company that created the VelocityShares Daily 2x VIX Short-Term ETN (NYSEARCA:TVIX) and the VelocityShares Daily Inverse Short-Term ETN (NYSEARCA:XIV).

…OK, maybe you didn't miss them, but I kind of did. I saw the header go by, but didn't read about them until the weekend.

Anyways, Velocity has two new ETFs for us. First up, we have the VelocityShares Tail Risk Hedged Large Cap ETF, or TRSK:

TRSK seeks to reflect the performance of the VelocityShares Tail Risk Hedged Large Cap Index before fees and expenses. The fund takes a net long position in large-cap equities, and a (net) short position in [CBOE Market Volatility Index (VIX)] futures.

…At present the fund holds just a handful of securities. The top 3 holdings are actually ETFs; Vanguard S&P 500 ETF (VOO), SPDR Trust Series 1 (SPY) and iShares Core S&P 500 ETF (IVV). The trio contributes 85% to the fund, leaving the rest for 2x long volatility (5.55%), and inverse volatility (9.45%).

The approach is designed to hedge "tail-risk" in the S&P 500, potentially making it a lower risk choice during turbulent market times. However, in rising markets, the ETF could underperform as the volatility component could push this product below unhedged funds.

Now I'm guessing that "(net) short position in VIX futures" means they actually own the VIX futures and are converting them (for allocation purposes) into the equivalent shares of short SPY. In other words, if a VIX future has a -2 Beta, buying about 4.5 of them equals shorting one SPY. And in fact, they're not actually long VIX futures, but rather, they own a leveraged volatility ETF [I assume TVIX or the ProShares Trust Ultra VIX Short-Term Futures ETF (NYSEARCA:UVXY)] and are presumably short inverse volatility (via the XIV, most likely).

In addition, they've listed the VelocityShares Volatility Hedged Large Cap ETF, or SPXH:

SPXH seeks to reflect the performance before fees and expense of the VelocityShares Volatility Hedged Large Cap Index, which hedges "volatility risk" in the S&P 500. The fund takes a long position in the S&P 500 and a (net) long position in short-term VIX futures.

…At present SPXH holds just a handful of securities as well. Once again, ETFs comprise the bulk of the exposure with the Vanguard S&P 500 ETF, iShares Core S&P 500 ETF and the SPDR Trust Series 1 accounting for 85% of the fund. The remainder goes to volatility with 3.9% going to 2x volatility, and 11.1% to inverse volatility.

This approach looks to hedge "volatility risk" in the S&P 500. The strategy could also be ideal during sluggish market conditions, but like its TRSK counterpart, could underperform during rising market environments.

All of this begs the question, why? Well, setting aside the obvious answer of "fee generation for Velocity," what need do these funds potentially fulfill?

It's not a tough concept to replicate on your own. If you own stocks already, it would involve simply buying and managing some volatility products. But since many don't have the time and/or confidence and/or inclination to try it on their own, it does help to have an ETF do it for you.

But then, why do this with VIX futures or volatility ETNs? Well, Velocity invented some of them, so it's easy to say why they would like to use their own VIX "offspring." For the average investor though, these offer no advantage. You can achieve the same outcome by simply owning out-of-the-money puts versus a long portfolio. In fact, you'd likely achieve a better outcome.

TVIX and UVXY are about the worst products ever invented, at least in terms of performance. They carry all the contango risk of the iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA:VXX), combined with the compounding risks of leveraged tracker ETFs. They offset it to a minor degree by apparently shorting the XIV. But that's a very minor offset. It's the same thing as owning the VXX, but with a small benefit of being short the compounding.

I'd completely avoid these two new ETFs. If you'd like to reduce market exposure, I'd strongly recommend something like buying and/or rolling modestly out-of-the-money index puts with a duration of about three-to-six months, as opposed to dabbling in TRSK or SPXH.

Disclaimer: The views represented on this blog are those of the individual author only, and do not necessarily represent the views of Schaeffer's Investment Research.

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