chief investment officer effectively using etf.com …33 $35 $37 $39 $41 $43 $45 spot sep-11 oct-11...

Dave Nadig Chief Investment Officer ETF.com

ETFs 304: Effectively Using

Alternative, Leveraged & Inverse ETFs

Paul Britt, CFA Senior ETF Specialist ETF.com

1. Do geared ETFs have a role in client portfolios?

2. Should anyone own VIX ETFs?

3. Can you buy hedge fund exposure in an ETF?

ETFs 304 - Questions

1. Geared ETFs can hedge specific risks, but you must rebalance

ETFs 304 - Answers


2. No one should “own” VIX ETFs

ETFs 304 - Answers



3. ETFs don’t hold hedge funds, but they can act like one

ETFs 304 - Answers

Leveraged & Inverse

Source ETF.com, as of 12/31/2013

• 266 Funds

• $40B Total AUM

• 42 Funds AUM/ADV < 15

Leveraged & Inverse - Landscape


Leveraged & Inverse - Landscape

0%10%20%30%40%50%60%70%80%90%

100%

2009 2010 2011 2012-3 -2 -1 2 3

ETF Assets by Daily Multiple

Geared ETFs can:

• Be used for speculation

• Make calls with less capital

• Make nuanced hedges

Leveraged & Inverse

To get the multiple over time, you must

Leveraged & Inverse

Leveraged & Inverse: Mind the Gap

-20%

-10%

0%

10%

20%

30%

40%

50%

07/08/2013 07/08/2014

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Daily Financial Bull 3x Shares (FAS) naïve 3x R100 Financials Index

Leveraged & Inverse: Daily Reset Level ETF's Exposure

Before Reset ETF's Exposure

After Reset Day 1

Index 100 -200 -200 ETF 100

Day 2 - Index up 10%, ETF Loses 20 Index 110 -220 -160 ETF 80

Day 3 - Index down 10%, ETF gains 16 Index 99 -144 -192 ETF 96

Level ETF's Exposure Before Reset

ETF's Exposure After Reset

Day 1 100 -200 -200 100

Day 2 - Index up 10%, ETF Loses 20 110 -220 -160 80

Day 3 - Index down 10%, ETF gains 16 99 -144 -192 96

Leveraged & Inverse: Rebalance!

2 Day Index return: -1% 2 Day -2x Naïve Return: 2% 2 Day -2x Actual Return: -4%

-60%

-40%

-20%

0%

20%

40%

60%

31/12/2009 31/12/2010

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FAZ FAS R1000 Financial Index

Risks & Daily Resets

Source Bloomberg, as of 12/31/2013

Leveraged & Inverse: 2013 returns

Leveraged & Inverse: How to • Rebalance!

• Trade Skillfully

• Understand the gearing

• Know the underlying

A Note On Volatility • High Volatility/Trendless markets: L&I funds

underperform • Low Vol/Trending markets: L&I funds

outperform

• Sophisticated traders: • You can “extract vol” by shorting the levered

fund while going long the underlying.

Alternatives

Alternative Product Summary

Spread Products • Take offsetting futures positions with little or

no exposure to underlying asset

Volatility Products • Seek upside from equity volatility using VIX

futures

Hedged Products • Aim for positive, steady, uncorrelated returns

Alternative Product Summary Absolute Returns Tactical Tools

Global Macro # Spreads # Hedge Fund Replication 2 Inflation 2 Inflation 3 Long/Short Volatility 1 Low Correlation 1 Risk 1 Tactical Asset Allocation 3 Yield Curve 1 Trend-Following 1

Long/Short # Volatility # Long/Short Broad-based 4 S&P 500 Mid-Term 4 Long/Short Commodities 1 S&P 500 Short-Term 3 Long/Short Currency 2 Trend-Following 1 Long/Short Equity 9 Merger Arbitrage 3

*Table excludes Leveraged & Inverse funds


Spread Products

Objectives • Aim to Harvest Contango

• Capture gains from steepness of futures curve • Example: OILZ ETRACS Oil Futures Contango ETN -

Short front-month futures, long 6th, 7th & 8th month

• Aim to Capture Market Expectations • Yield Curve • Inflation

VIX ETFs: The Promise “The Dow Jones

Industrial Average took its steepest dive

of the year on Thursday, losing 353 points a day after the

Federal Reserve hinted it might end

its bond-buying stimulus program

later this year” The Wall Street Journal, 6/21/2013

VIX Correlations

Name Correlation Beta VIX -0.76 -4.58

S&P 500 VIX Short-Term Futures -0.79 -2.73

S&P 500 VIX Mid-Term Futures -0.77 -1.27

Source Bloomberg, CBOE

Correlation & Beta of VIX and S&P VIX Futures Indexes Relative to S&P 500 1/22/2009–3/31/2014

VIX Correlations

Name Correlation Beta S&P 500 VIX Short-Term

Futures 0.90 0.52

S&P 500 VIX Mid-Term Futures 0.81 0.22

Source Bloomberg, CBOE

Correlation and Beta of VIX and S&P VIX Futures Indexes Relative to VIX, 1/22/2009–3/31/2014


VIX ETFs: the Problem

-60%

-40%

-20%

0%

20%

40%

60%

80%

07/08/2013 07/08/2014

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VIX Index VXX

-110%

-90%

-70%

-50%

-30%

-10%

10%

30%

29/01/2009 29/01/2010 29/01/2011 29/01/2012 28/01/2013 28/01/2014

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VIX Since Inception

VIX Index VXX

VXX: A Long Run Wealth Destroyer

Source: Bloomberg, ETF.com, 1/29/2009 – 8/7/2014

Net Inflows: $6.5 Billion AUM: $1.0 Billion

$13

$14

$15

$16

$17

$18

$19

$20

$21

feb-13 mar-13 abr-13 may-13 jun-13 jul-13 ago-13 sep-13 oct-13

VIX ETFs: Contango VIX Index Futures Curve


$25

$27

$29

$31

$33

$35

$37

$39

$41

$43

$45

Spot Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12

VIX ETFs: Backwardation VIX Index Futures Curve


VIX ETFs – Decay

Each Total

5 contracts Feb 14 30 days to expiry $20 $100

5 contracts Feb 14 1 day to expiry $16 $80

4 contracts Mar 14 30 days to expiry $20 $80

Roll

Day 1

Day 30

The VIX Moment

-100-50

050

100150200250300350400

S&P 500 Short-Term Vix Index Mid-Term Vix Index

It Works! (2007 – 2009) S&P 500 90/10 Short-Term Vix 90/10 Mid-Term Vix

Total Return -26.56% -18.33% -16.01% (Annualized) -9.78% -6.53% -5.65% Standard Deviation 52.00% 37.92% 41.89% (Annualized) 30.02% 21.89% 24.19%

Until it doesn’t … (2010 – 2014)

S&P 500 90/10 Short-Term Vix 90/10 Mid-Term Vix Total Return 88.02% 31.06% 55.44% (Annualized) 15.46% 6.35% 10.56% Standard Deviation 34.73% 20.52% 25.94% (Annualized) 16.57% 9.79% 12.38%

VIX ETFs VIX Index: • Volatile but Mean Reverting

VIX Futures ETFs: • Spike and Bleed

VIX ETFs: How to • Trade, Don’t Own

• Short Term vs Mid Term

• Not ‘40 Act

Hedge Fund ETFs Hedge Fund ETFs Don’t

Hold Hedge Funds

Hedge Fund ETFs

Objectives:

• Positive Returns in All Markets

• Uncorrelated Returns with Major Asset Classes

Means: • Hedge Fund Strategies

• Replication

• Copy Cat

Hedge Fund ETFs

Characteristics: • Multi-Asset

• Long/Short

• Low or No Beta

• Exposure: ETF of ETFs, Derivatives, Securities

• High fees

• Disparate performance

Hedge Fund ETFs: 2013’s Best?

Hedge Fund ETFs – the Rest

Hedge Fund ETFs: How to • Screen for Size and Liquidity • Match Strategy to Goal • More Due Diligence

• Cash—Collateral, Tactical or Strategic • Derivatives Exposure: Notional vs Market Value • Costs – Holding, Trading, Due Diligence Time • Short Exposure – Direct or Derivatives? • No Downside Guarantee

Notable Events in Alternatives • September 2011: E-TRACS

• Shutters 12 alternative volatility ETNs

• November 2012: QuantShares • Shutters 3 market neutral funds

• August 2014: IndexIQ

• QAI assets ~ $800M

1. Geared ETFs can be useful, but you must rebalance


3. ETFs don’t hold hedge funds, but they can act like one

ETFs 304 - Summary

Thank You

Dave Nadig Chief Investment Officer ETF.com

ETFs 304: Effectively Using

Alternative, Leveraged & Inverse ETFs

Paul Britt, CFA Senior ETF Specialist ETF.com

chief investment officer effectively using etf.com …33 $35 $37 $39 $41 $43 $45 spot sep-11 oct-11...

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