The Worst ETF In The World

There are some stinkers out there, but this crazy ETF takes the cake.

It’s not often you get the opportunity to make such a clear call, but I think I’ve figured out the single worst ETF on the planet. It’s honestly not even close.

Ladies and gentlemen, meet the Elements Linked to Spectrum Large Cap U.S. Momentum ETN (EEH), and let me explain why it’s a problem, not just for people dumb enough to be owning it, but for the ETF industry and the New York Stock Exchange.

The Elements are an extremely bizarre series of exchange-traded notes (ETNs), originally cooked up by Merrill Lynch back in 2007. I say “cooked up,” because as an ETN, there are a lot of cooks in the kitchen, and ultimately, not much real ownership. Merrill was basically just acting as an underwriter, trying to create product it could sell. That’s the business of underwriting brokers.

So it (presumably) contacted the Swedish Export Credit Corporation and asked if it was interested in making 75 basis points a year for underwriting a little piece of debt tied to a dirt-simple momentum index published by BNP Paribas. Everyone said yes, and EEH was born on Aug. 1, 2007.

Compared with what happens after this part of the story, it was a fairly good year for EEH, though not really in a performance sense—investors lost money, but the fund actually traded a few shares now and then:

The Falling Out

But then a little thing called the global financial crisis happened, and EEH—like virtually all of the other products being distributed by Merrill under the Elements umbrella—was forgotten. Mostly, it was forgotten by investors:

The volume dried up, and as you can see from the red line here (which is the shares outstanding), by 2009, most of the initially created shares had been put back to the Swedish Export Credit Corporation. By calendar year 2012, it was trading 40,000 shares a year. That’s right. All year long, just 40,000 shares traded hands. Still, miraculously, it somehow managed to trade at something like fair value.

I say “miraculously” because it wasn’t just investors who forgot about the Elements. Throughout most of the last five years, there’s literally been nobody home at Merrill to claim these products. We’ve tried countless emails, phone calls and personal pleas, and never had anyone stand up and take ownership.

For a few years, the website was stuck in a time machine. In 2009, Credit Suisse had the grace to formally delist three Elements ETNs that had gone fallow with Credit Suisse as the underlying bank. In 2011, Deutsche Bank played Boy Scout and just called the three ETNs it had its name behind, handing existing shareholders’ cash. And as far as anyone can tell, that’s the last time anyone touched the website except to advance the copyright date to 2014.

So already, any of the Elements ETNs would be candidates for “worst ever.” But there have been a few holdouts. The ETFs associated with the Rogers commodities indexes have real money in them. The Elements Rogers International Commodity Total Return ETN (RJI | B) has almost $800 million under management, despite the website being down. (At least Rogers maintains an index website you can find easily.)

Things Get Nefarious

The real prize actually comes from recent activity. Check out the last year in EEH:

The first thing to look at is the green line—again, that’s the shares outstanding in EEH. Last fall, around Sept. 23, someone rolled up 94,470 shares and handed them back to our friends in Sweden. It would have to be someone with a special relationship, because according to the pricing supplements, blocks need to be worth more than $5 million to be eligible for repurchase, but since there was only $1.4 million of EEH in existence at the time, someone was feeling charitable.

And charity it would be. At the time of the big redemption, EEH was trading—a word I’ll use loosely to describe the few hundred shares that would occasionally cross the tape—at a slight discount. So, theoretically, someone could have been slowly buying at a discount and then redeemed at fair value. I remember thinking at the time: “Finally, someone will put this thing out of its misery.”

But then we saw a very slight increase in volume—and a huge premium appeared.

That black line is the end-of-day pricing in the open market. The blue, boring one is what EEH was actually worth. Big premiums on small ETFs with no liquidity aren’t that uncommon. What is uncommon is that someone—and it really would have to have been Merrill or someone who actually knows who to call at Merrill—had the gall to then issue a new 50,000 share block of EEH.

Those shares dribbled into the market in October and November, collapsing the premium. Remember that every trade has two sides: Someone out there was buying these newly minted shares at ridiculous prices—hundreds of percent over fair value.

And now it’s just silly …

Things cooled off for a while, until the last few weeks, when the pattern seems to have repeated. This time, however, volumes have been off the charts—in relative terms. On the peak-volume day of Aug. 25, when more than 40,000 shares changed hands, this is what the tape looks like:

Page after page of subpenny trades being reported on ‘Form-T’—the manner in which off-market high-frequency trades get reported.

What’s happening here is the seedy underbelly of the industry. Somewhere in New Jersey, perhaps, there are algorithms sniping each other over an ETN that frankly shouldn’t even exist. My guess is that these HFT algos don’t even recognize that EEH is an ETF, or that a thing such as fair value even exists. They’re just looking for patterns and pouncing on anything that moves. Miniscule, million-dollar ETNs like EEH are enormously susceptible to this. But because nobody’s minding the store, nobody’s going to complain.

If this kind of insanity were happening to a microcap stock, most likely the chief financial officer of the company would get on the phone and halt the trading in his own shares. But there’s no CFO for EEH. Not only is nobody home, the lights aren’t really—if we’re being honest—even on.

A Modest Proposal

So here’s my question: When does the NYSE end up being the Boy Scout here?

This is clearly a security that isn’t functional. No rational investor, or even nonmechanical trader, would really look twice at it. But because (I’m guessing) the requirement for trading under a dollar isn’t being met, there’s no automatic mechanism to kick this thing out of the public markets once and for all. Shouldn’t the host of the party tell the drunk guests when it’s time to call a cab and go home?

The role of exchanges is to provide orderly markets for the allocation of scarce capital. I have no idea what the heck is going on in EEH, but I’m darn sure it’s not that.

At the time this article was written, the author considered EEH the worst ETF in the world, and thus, of course, did not own it. You can reach Dave Nadig at [email protected], or on Twitter @DaveNadig. Oh, if you’re the one at Merrill who owns these things, would love your phone number! We’ve been trying to reach you for years!