UBS this week brought to market an exchange-traded note that provides exposure to the S&P 500 Index but with a built-in mechanism that can dampen market volatility when markets become roiled through the use of an a VIX-related overlay.
The “UBS AG Exchange Traded Access Securities (E-TRACS) S&P 500 VEQTOR Switch ETN”—the lengthy name a function of the fact that ETNs are registered under the Securities Exchange Act of 1933—pivots around a market volatility target of 10 percent. Once that target is reached, the strategy trims S&P 500 exposure in favor of the S&P 500 VIX Futures Long/Short Switch Index, according to regulatory paperwork UBS filed.
The ETN, which launched Wednesday, Dec. 3, is trading with the ticker “VQTS” and comes with an annual fee of 95 basis points, or $95 for each $10,000 invested, according to the pricing supplement UBS filed with the Securities and Exchange Commission.
Because the backing bank of an ETN (UBS in this case) is obligated to deliver just the returns of the index regardless of how its capital markets desk comes up with that income stream, ETNs can be flexible and rather creative in their exposure schemes compared to ETFs. VQTS’ exposure concept speaks to this ETN characteristic.
At the same time, ETNs can also be complex to an intimidating degree, which might explain their somewhat-limited allure in the rapidly expanding world of exchange-traded products. Including VQTS, just 214 of the more than 1,600 exchange-traded products are ETNs.
Perhaps more to the point, ETNs are, unlike ETFs, debt instruments. That means if their backing bank should become insolvent, investors in ETNs risk losing their entire investment.
Because ETNs are debt obligations—and are not, as ETFs are, investment companies—ETNs are governed by the so-called ’33 Act and are regulated by the SEC’s Division of Corporate Finance. Most ETFs, by comparison, are registered under the Investment Company Act of 1940 and are regulated by the SEC’s Division of Investment Management.
Inside The Index
The futures index component of VQTS seeks to simulate a dynamic portfolio that allocates between cash and VIX futures with the aim of capturing VIX futures roll yields when volatility drops (“short”) and VIX futures upside when volatility spikes (“long”), UBS said in the filing.
The VIX futures component of the futures index switches between a long and short S&P 500 VIX futures position with a constant one-month maturity. The futures index has a constant scale factor of one-third on the VIX futures position to mitigate volatility, with the balance of the futures index representing cash, UBS said.
The S&P 500 component is based precisely on the S&P 500 Total Return Index.
In sum, UBS has organized the entire security around what it calls the S&P 500 VEQTOR Switch Total Return Index, which appears to be a fresh creation in the world of indexes and exchange-traded products.