Daily ETF Watch: Promising New VIX Funds

ETF industry newcomer AccuShares today is rolling out the first of its planned suite of 12 ETFs that are designed to provide spot and inverse spot exposure to various indexes that were previously only tracked by futures. The first of the new funds, the AccuShares Spot CBOE VIX Up Shares (VXUP) and the AccuShares Spot CBOE VIX Down Shares (VXDN) are designed to offer long and inverse exposure to the value of the VIX, respectively.

Crucially, none of the AccuShares products invests directly in futures to get its exposure to the VIX. Instead, they invest in cash and cash equivalents and use algorithms to distribute gains or losses to investors. Cash distributions will occur on at least a monthly basis and assets will flow back and forth between the two products.

The AccuShares pitch to investors looking to dampen portfolio volatility with such products is that, unlike existing VIX-linked exchange-traded products, these will not be dragged down by the vagaries of futures-based investing.

Specifically, the AccuShares products won’t suffer from contango or “negative roll yield,” which refers to the corrosive long-term effects that frequently accompany futures-based exposure. Contango refers to maintaining exposure with futures contracts when expiring contracts are sold for less than the cost of contracts subsequently bought to maintain exposure.

The three-year chart below compares the changes in the value of the VIX Index in black with the changes in price—in blue—of the ETF market’s biggest VIX-linked products by the assets, the $1.2 billion iPath S&P 500 VIX Short-Term Futures ETN (VXX | B-62). Yes, a general decline in volatility is to blame for VXX’s decline, but that variable pales in comparison with the effects that the voracious gods of contango have had on the ETN’s price.

Chart courtesy of StockCharts.com

Proof Will Be In The Pudding

The exact structure of the funds has never been attempted, but these aren’t the first funds of this nature. The AccuShares call to mind the MacroShares ETFs, the first of which launched in 2008. The “up” and “down” funds were tied to the S&P/Case-Shiller 10-City Composite Home Price Index, and basically invested in Treasurys, shifting assets between the two portfolios as the index moved up and down, a bit like a teeter-totter.

It should also be noted that the MacroShares came with an expiration date when investors would receive a lump sum. The funds didn’t trade for very long, and the last ones ended up closing in 2009.

It’s Complicated

But the AccuShares are not meant to be long-term investments. The funds’ prospectus repeatedly warns investors that they should not invest in the products if they are intending to use them as buy-and-hold passive investments.

It notes that investors who don’t intend to look at their portfolios “at least as frequently as each distribution date” should not use VXUP and VXDN. Regular distributions are made on the 15th of each month.

One of the problems with the MacroShares was that one side of the teeter-totter structure (the up or down pairs of funds) would draw all the assets away from the opposing fund. Such imbalances led to the closure of both funds.

It looks like the AccuShares products will resolve this by resetting the up and down shares to equal values after each monthly distribution and by limiting the amount either fund can go up in a single month to 90 percent. Distributions will not be made if they will result in one of the funds fund having less than $25 million.

Authorized participants (APs) must also create or redeem shares in equal blocks, meaning that if an AP creates 25,000 shares of VXUP, they must also create 25,000 shares of VXDN.

A Daily Amount

In addition, if the VIX is at or below 30 on the distribution date, then on a daily basis, 0.15 percent of the value of VXUP’s portfolio on its distribution date is shifted over to VXDN’s portfolio. This is due to the mean-reverting nature of the VIX. Unlike the S&P 500 Index or the Dow Jones industrial average, for example, the VIX reflects volatility, which tends to be cyclical and revert to a mean more so than stock market performance.

The prospectus indicates that the “Daily Amount” subtracted from VXUP’s portfolio is intended to reflect the deterioration in long instruments that occurs when the VIX reverts to its mean. When the VIX is over 30 on the distribution date, nothing is subtracted from either portfolio for the following period.

The AccuShares structure can be applied to any futures contract, and the firm has another six pairs of funds planned that will provide exposure to the world’s most widely followed commodity futures index, the S&P GSCI, and five of its subindexes.

VXUP and VXDN come with a management fee of 0.95 percent, or $95 per $10,000 investment.