Investing in volatility can be tricky business. A look at where money has been flowing when it comes to the volatility trade shows that nearly $2 billion in fresh net assets have gone into two of the most popular volatility ETFs this year, the iPath S&P 500 VIX Short-Term Futures ETN (VXX) and the ProShares Ultra VIX Short-Term Futures ETF (UVXY).
The flip side of this trade, inverse volatility ETFs, have generally been net asset losers, with strategies like the VelocityShares Daily Inverse VIX Short-Term ETN (XIV)—the largest volatility exchange-traded product, with $1.1 billion in total assets—and the REX VolMAXX Short VIX Weekly Futures Strategy ETF (VMIN)—facing some $180 million in combined net redemptions.
What’s interesting here is the performance of these volatility strategies. Year-to-date, it’s the inverse funds that are riding higher, and specifically, it’s the relatively young VMIN—the small ETF with only $13 million in total assets, and a pretty expensive strategy costing 3.13% in expense ratio—that’s leading the pack with a performance so stellar no other volatility strategy has been able to match.
Chart courtesy of StockCharts.com
VMIN is a unique fund, achieving that inverse exposure by shortening the term of the VIX futures it holds—it owns VIX futures with less than 30 days to expiration. By comparison, other short-term volatility products often rely on monthly contracts. And VMIN is actively managed. Greg King, founder of REX ETFs, and former co-founder of VelocityShares, gives us a run-down on how VMIN works, and what investors can expect from volatility investing.
ETF.com: Are you surprised by this year's record low volatility? What’s driving it?
Greg King: What's surprising is how long the low volatility environment has persisted. It's been around for quite a while, and the volatility spike that we saw around election time last year was extremely short-lived. I think a lot of people thought the outcome of the election might lead to a more persistent, higher-volatility regime. So it’s surprising how long it's lasted.
I'm not surprised that it's here, though. There are a lot of volatility-selling strategies out there, and there are some macroeconomic factors that continue to dampen volatility.
ETF.com: Is timing everything when it comes to investing in volatility products? Or it's just a matter of knowing what you're doing?
King: Yes to all of the above. Investors who are trading volatility products need to have a very good handle on how the markets are moving on a daily and even intraday basis. There are clearly better times than others to go long or short volatility. So there's a significant timing element to it.
We have seen an increase in the number of investors who are talking about maintaining longer-term positions that are short volatility in an effort to capture some premium. But keeping tabs on what you’re doing at all times is key.
ETF.com: Generally speaking, are volatility ETFs used more for speculation or for hedging? How are investors using these ETFs in a portfolio?
King: I think it's a fair amount of speculation for capital appreciation purposes, but also a fair amount of hedging. But portfolio hedging can be a speculative exercise itself. Often investors don't have hedges on until they feel the timing might be right to put a hedge on. Perhaps it would be better to say these investment products are typically used in a tactical way.
ETF.com: Let's talk about your vol ETFs. The inverse VMIN is up 148% this year, while the REX VolMAXX Long VIX Weekly Futures Strategy ETF (VMAX) is down 76%. In simple terms here, how do these products work?
King: Generally, our funds hold a basket of exposures to VIX. And they do so using a combination of weekly and monthly futures, as well as some exposures to other ETPs. In general, our “duration”—the average time to maturity of VIX futures' exposure—is somewhere in the low 20s in terms of number of days. It's a three- to four-week exposure.
What that means in the short fund, VMIN, is that, generally speaking, the fund is exposed to a part of the curve that's a little bit closer to spot than the benchmark index, the S&P VIX monthly futures index. That exposure is generally at a point in the curve that’s a little bit steeper. So that position will have a little bit higher beta to movements in spot VIX, according to research done by Cboe.