Nadig: My Biggest 2016 ETF Surprises

By any measure, 2016 was a momentus year. We lost Bowie, Prince and Cohen. We got the best Star Wars movie since 1977. And of course, there was an election cycle unlike anything we’ve ever seen. 

But while the ETF market may not catch the eyes of the TMZ reporters all that often, it’s still capable of making me think, “Huh, well how about that?” every so often.

Here were my two big “huhs” for the 2016:

VanEck Vectors Fallen Angel High Yield Bond ETF (ANGL)
The junk bond market has been a fantastic growth story or ETFs, not just this year, but in general. So far this year, the segment has taken in almost $5 billion in new money, dominated by two giants: the $18 billion iShares iBoxx $ High Yield Corporate Bond ETF (HYG), and the nearly-identical-but-for-details $12 billion SPDR Bloomberg Barclays High Yield Bond ETF (JNK). Those two funds combined pulled in $3.7 billion so far this year.

And yet, from both a “do I believe the story?” perspective and a “show me the money” perspective, there’s been a much better choice for the past three to four years, and it may finally be getting its moment in the sun: the VanEck Vectors Fallen Angel High Yield ETF (ANGL).

ANGL’s pitch is simple: Instead of just hunting for junk, it specifically looks for bonds that became junk later in life, but were issued as investment grade. 

The idea is that these companies aren’t in desperately troubled sectors of the economy, have good bones and simply hit some level of hard times that caused their ratings to fall. Companies that downgraded often get severely punished by the markets, making for opportunities for contrarian buyers—like ANGL. 

The resulting portfolio, to be impolite, has beaten the pants off not only the traditional big players, but upstart alternatives like the PowerShares Fundamental High Yield Corporate Bond Porfolio (PHB)—another fund whose methodology I really like, but that just hasn’t cut the mustard on performance:

Two Important Notes
The first is that if you run this analysis yourself, make sure you’re looking at total returns. With a 12-month trailing yield of nearly 6%, it’s important to make real apples-to-apples comparisons here. 

The second is that there’s a bit more going on here than meets the eye. Compared to a slow-and-steady traditional index ETF like HYG, ANGL makes some bets. It’s got significantly more duration risk, for one, with a current modified duration of 6.3 versus 3.7. That bet’s paid off, but in a rising interest rate environment, it’s worth paying attention to. Also, the turnover is about 35%, and that means things like credit rating and maturities can shift around quite a bit. 

Right now, ANGL is BB on average, versus B+ for HYG and JNK. Still, even with those shifting sands, the fund has been a consistent outperformer, beating the competitors in every calendar year since inception.

The head scratcher for me has been how long it’s taken the market to notice. The fund has managed to pull in a few hundred million in assets this year, but that’s still put it in fourth place in the flows table versus its closest competitors.

On The Other Hand … VelocityShares 3x Long Crude ETN UWTI(F)
As for downside surprises, it’s really impossible to overstate the importance of the absolute insanity that’s occurred in the market for exchange-traded notes (ETNs), most easily demonstrated by the VelocityShares 3x Long Crude ETN (UWTI, now UWTI(F) as it has been delisted). There’s no real need to revisit the original story, but in case you’ve been living in a cave: This once-$1.5 billion speculative vehicle was simply delisted by the issuing bank, Credit Suisse, without being called. The net result was weeks of chaos leading up to its eventual delisting. I even bought a few shares just to see what would happen. 

So why the surprise? Well, it’s by far the largest “closure” of a fund in ETF history. From the outside, it seems inconceivable any institution would walk away from $1.5 billion throwing off over 1% a year in fees, but that’s what they did, likely for balance sheet reasons (they’ve been mostly mum about the whole experience).

The real surprise may be where the situation stands today. VelocityShares—which is really just a marketing agent here and wasn’t responsible for the delisting—launched a new version of the ETN with the same name and similar ticker, the VelocityShares 3x Long Crude Oil ETN (UWT), with Citigroup behind the scenes. That fund, with a whopping 1.5% expense ratio, has pulled in $140 million, and is trading a healthy 2 million shares a day, on average. 

But the delisted version? It’s still got more:

Hundreds Of Millions Of Dollars In UWTI(F)
The middle chart here is the assets under management of UWTI(F). You can see back in November, it still had over $1.5 billion in assets. Volumes have mostly disappeared, as you now have to find a buyer on the pink sheets, but remain higher than many ETFs, averaging about 200,000 shares changing hands daily, generally within a few percent of fair value. And still, more than $260 million remains in the fund. 

While Credit Suisse still won’t shut down this note, it did lower the redemption amount to 500 shares. That means the total investment required to try and buy low on the pink sheets and present to the issuer for fair value to book an arbitrage profit is just $12,000 or so. In reality, we’re seeing a slow and steady decline, day by day—100,000 shares or so at a time.

This means somewhere out there is a legion of small traders and market makers who are going to slowly bleed down the assets on this thing for who knows how long, until finally all that’s left is a rotting few-million-dollar carcass of a once-enormous fund. 

Maybe then Credit Suisse will finally put UWTI(F) out of its misery, and put an end to one of the weirdest stories in the past 25 years off ETF history.

At the time of writing, the author held no positions in the securities mentioned. Contact Dave Nadig at [email protected].