An “investor” is born (or, given the externalities inherent in this snake pit, perhaps “borne” is the word) every minute.
Well said, BlackRock boss: “For its part, BlackRock has steered clear of leveraged ETFs. CEO Laurence Fink told the audience at a Deutsche Bank-hosted investor conference in 2014 that: ‘We’d never do one. They have a structural problem that could blow up the whole industry one day.'”
Via Grant’s Almost Daily (sorry, no link):
Day traders delight
The revolution was not, in fact, televised. A simple press release filled the bill instead. This morning, BlackRock released its ETF Pulse Survey, a look at the pace of exchange traded fund adaptation across different demographics. The survey of individual investors found that only 27% of baby boomers (aged 52 to 70) own ETFs, compared to 42% of millennials (21 to 35) and 37% of “silvers” (aged 71 or older). Martin Small, head of BlackRock’s iShares unit in the U.S., surmised that boomers: “May still be holding onto a stock-picking mentality. They may not realize that ETFs are as easy to trade as stocks and available in virtually every market segment imaginable. As a result, many pre-retirees and investors in their early years of retirement may be overlooking the ETF revolution.”
Much as crypto-currencies run the gamut from relatively established first movers like bitcoin to ICO’s such as “Lehman Brothers Coin” (Almost Daily Grant’s, Jan. 19), so does the exchange-traded fund realm range from the simple (such as the SPDR S&P 500 ETF Trust, or SPY on NYSE Arca, which today crossed the $300 billion in assets under management for the first time), to the exotic.
For a demonstration of the latter, we turn to the BMO Rex Microsectors FANG+ Index 3x Levered ETN (FNGU on NYSE Arca) and its evil twin, the FANG+ Inverse Leveraged ETN (FNGD on same), which debuted yesterday. Bloomberg Intelligence harkened the vehicle’s debut with the apt headline: “Leveraged FANG ETNs Aim to Bring Volatility to Bored Traders.” The ETN will charge a 95 basis point expense ratio (10 times the SPY), while the underlying FANG+ Index comprises equal weighted holdings of Facebook, Inc., Apple, Inc., Amazon.com, Inc., Netflix, Inc., and Alphabet, Inc., (nee Google), as well as Alibaba Group, Baidu, Inc., Nvidia Corporation, Tesla, Inc., and Twitter, Inc,.
Eagle-eyed readers will spot that those leveraged securities are classified as ETNs, or exchange traded notes, rather than the conventional ETFs. The Wall Street Journal explained the difference on Feb. 5, 2017:
Both ETFs and ETNs track the price of things like baskets of stocks, bonds or commodities, but they do so differently. ETFs own a portion of the assets they track – an S&P 500 ETF, for instance, owns stocks that are included in the index. ETNs don’t own a portfolio of assets. They are simply debt issued by banks that promise a return to the investor linked to the performance they track.
Indeed, the registration statement filed with the SEC states that: “The notes are unsecured [and] . . . do not guarantee any return of principal.” As for the leverage factor, the document carries the following disclaimer: “The notes are riskier than securities that have intermediate- or long-term investment objectives, and may not be suitable for investors who plan to hold them for a period other than one day or who have a ‘buy and hold’ strategy . . . Investors should actively and continuously monitor their investments in the notes, even intra-day.”
The May 19, 2017 analysis in Grant’s (“Loaded for bear”) took a different tack in describing these products which evidently require a day trader’s attention (and attention span): “Take every known principal of long-term investment success, negate those precepts and multiply the negative by leverage. That would be one aspect of the 4X, 3X or 2X story.” Why? Biff Robillard, co-founder of Bannerstone Capital Management LLC, explained the problem: To make money in leveraged ETF’s, one must correctly predict not only the direction of prices, but of their realized volatility as well.
Not the implied volatility, and not the VIX per se, [but] the actual volatility that the underlying entity driving valuations will experience going forward. You have to have an opinion about that. High volatility reduces, even reverses, returns on leveraged ETFs.
The piece then goes on to demonstrate a hypothetical example:
Say that you own $100 of a thrice-leveraged ETF. On day one, the underlying index moves up by 5% – your fund as gains three times $5; it’s worth $115. Next day, the index falls by 5%; oops, your fund is now worth $97.75. Repeat across 10 days – alternating up 5% and down 5% – and you would finish with $89.23, down by 10.8%. Over the same course of choppy trading days, an unlevered fund would have lost only 1.2%.
So too, does the leverage mandate pose the potential to exacerbate market volatility, should this period of historic serenity be interrupted:
In a conventional margin account, leverage ratios fall as the value of portfolio assets rise. Not so here. An ultra ETF keeps its leverage constant by boosting its indebtedness – drawing on its swap arrangements – as the value of its assets appreciates. To bulk up in a rising market and sell down in a falling one is a technique that recalls the misadventures of portfolio insurance [an aggravating factor in the 1987 stock market crash].
For its part, BlackRock has steered clear of leveraged ETFs. CEO Laurence Fink told the audience at a Deutsche Bank-hosted investor conference in 2014 that: “We’d never do one. They have a structural problem that could blow up the whole industry one day.” That prompted a rejoinder from Trevor Hewes, spokesman for ProShares, which offers many such products: “Leveraged ETFs are well regulated, transparent products and there is no credible evidence that they have any harmful effect on the markets or our industry.”
For our part, we wonder about the soundness of ETFs as a whole, not just the plainly perilous leveraged variety. Recall the increasingly distant (in terms of time elapsed and market environment) events of Aug. 24, 2015, a steep sell-off that left the S&P 500 lower by as much as 5.2% intraday and 3.9% by the close. In that session, even straightforward ETFs were severely dislodged, with the SPY falling by nearly 8% intraday. The S&P 500 equal-weighted index dropped by as much as 4.6%, while the Guggenheim S&P 500 equal-weight ETF sank by as much as 43%, before finishing in the red by just 4%.
Presented without further interruption…
Hopefully you don’t need a refresher on this, because if you do it likely means you haven’t been paying much attention to how shifts in market structure are creating systemic risks that no one understands, but just in case, the idea is that thanks to the low starting point on the VIX, a nominally small spike could force inverse and levered VIX ETPs to panic buy VIX futs into said spike, thus exacerbating the situation and ultimately forcing CTAs, vol. control funds, and risk parity to deleverage into a falling market.
Does this represent the ultimate in the “tight coupling” risk management problem (e.g., Feynman’s view of the Challenger disaster, Rick Bookstaber’s take on financial meltdowns, etc.)?
“Applications of AI and machine learning could result in new and unexpected forms of inter-connectedness between financial markets and institutions, for instance based on the use by various institutions of previously unrelated data sources,” said the FSB, in its first dedicated report on AI.
Excellent post on active investment management’s Hobson’s choice – retreat to the sidelines or get your high-fee ass kicked by de minimis fee index funds.
From Heisenberg Report:
We – and plenty of others – have noted that active management has begun to throw in the towel when it comes to besting passive. How do you outperform a benchmark that’s being driven by a perpetual motion machine? You can’t. And especially not when you’re playing from behind by virtue of the fact that the people replicating that benchmark are paying as little as 5bps in fees to participate. And so, what do active managers do? Well, they just stop trading. They become passive investing vehicles themselves.
“Sorry, I gotta go pick some stocks….”
“No, baby. That business is dead….”