Investors may want to add “volatility” to the old axiom of “nothing’s certain, but death & taxes.” That’s because volatility — or the market’s up and down swings — has been a norm for many portfolios since the Great Recession.
Since that time, investors have tried to cope with these movements via various means. From bonds and stock-like fixed-income assets to funds that seek to limit tail-end risk, investors have plowed some serious coin into products designed to smooth-out their portfolio’s roller coaster.
One of the most popular has been betting directly on the CBOE Volatility Index via various VIX ETFs.
These exchange-traded funds (ETFs) try to bet on the price movements via futures contracts on the so-called “fear index.” While the VIX itself isn’t so fearful, the various VIX ETFs are truly frightening. Many have been huge capital sinks for portfolios.
However, a new fund sponsor may have finally designed a better VIX ETF mousetrap. For investors, AccuShares Investment Management LLC offers new way of dealing with futures could be a game changer for VIX ETFs, as well as traditional commodities ETFs.
VXX ETF: Going Down?
The most popular VIX ETF happens to be the iPath S&P 500 VIX Short Term Futures TM ETN (NYSEARCA:VXX). It also happens to be one of the worst long-term investments an investors could make. Ever since its inception, the VXX has been one of the quickest ways for investors to lose money.
The problem with the VXX and many of its sister VIX ETFs has to do with just how they roll over their futures contracts. Commodities and futures investors need to familiarize themselves with concepts of contango and backwardation.
A futures contract is said to be in contango when later-dated contracts trade at higher prices relative to contracts that are close to maturity. When a futures-based ETF sells the near dated contract and buys the farther out one, they are basically selling low and buying high. That causes them to lose money.
Now, not all commodities funds are designed to automatically buy the near-dated futures contracts. Some use optimum rolling strategies and the like. However, many do — especially funds that promise “near-spot” pricing.
The previously mentioned and uber-popular VXX, is a near-dated fund only. Therefore, it will keep on tanking for basically forever. As a trading element, it works. But it is definitely not a long-term hedge against volatility.
New Commodities ETFs
That’s where AccuShares’ new funds the AccuShares Spot CBOE VIX ETF Up Class Shares ETF (NASDAQ:VXUP) and Down Class Shares (NASDAQ:VXDN) come in handy. Both VXDN & VXUP use a new method to track spot VIX prices, meaning investors are actually getting exposure to the index rather than just using futures that could have problems in times of contango.
The new VIX commodities ETFs don’t actually hold futures, but instead hold hold cash, T-bills, bonds and other U.S. Treasury securities. VXUP & VXDN swap these assets back and forth based on the increase or decrease in the spot price of the VIX or other commodity. The new indexing methodology will also recalibrate the ETFs on the 15th of every month and distribute index returns via dividends. Investors will get a 1099 statement rather than a dreaded K-1.
This strategy may sound familiar. The now-defunct Macroshares tried a similar asset-swap ETF model back in 2008-2009. However, its products didn’t have the monthly reset, so eventually the down products hit $0 and were forced to close.
By using the swap method and rebalancing, the new VIX ETFs should be able to track spot volatility prices more closely than other VIX ETFs and eliminate much of the roll-cost issues. VXUP & VXDN aren’t cheap, though. Expenses for each ETF is 0.95% per year — or $95 per $10,000 invested. VXUP has an additional 0.15% daily fee to help compensate holders of the VXDN, because a short position in the index is likely to lose money over the long haul.
And yet, despite that hefty fee structure, the two funds should help overcome the issue and costs related to other VIX ETFs. It’ll actually be cheaper to use the new ETFs rather than products like the VXX.
Should You Buy The New VIX ETFs?
Maybe. VXUP & VXDN are geared towards traders; however, investors who are worried about volatility in the near-to-medium term should benefit from adding VXUP. If you think we are in for some turbulence, adding it to a portfolio makes sense. It’s still a cheaper option than many other VIX plays. The fees will begin to bite in the longer term, though.
What’s more exciting about the funds is the actual structure.
The asset swap plus the rebalance is interesting to investors looking at commodities like oil, natural gas, copper, and corn — sectors that are prone to huge bouts of contango. AccuShares plans on listing other commodities products that use the same method. Those shouldn’t come with that extra 0.15% daily fee and will actually be worthwhile for investors looking to play long-term spot prices in these various commodities.
As for the VIX ETFs, investors now have a more accurate tool for tracking and potentially hedging their portfolios against volatility. They could be definitely be useful as short- or medium-term hold if things begin to get wonky again.
AccuShares may just have a hit on its hands with VXUP, VXDN and its new ETF structure.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.
