ETF Of The Week: Indian Premiums & Returns

If you've checked out our performance widget lately, you've probably noticed something strange: The Market Vectors-Indian Rupee/USD ETN (INR), a tiny exchange-traded note with barely $1 million invested, has been burning up the leaderboard.

Over the past month alone, it's returned 97.3%:

Source: ETF.com; data as of Sept. 26, 2019

This outperformance seems to fly in the face of common sense, given that the note, which tracks the spot exchange rate between the U.S. dollar and Indian rupees, should be reflecting a much more modest rise. Since Aug. 26, the rupee has risen only 2% compared to the greenback.

INR's soaring performance is largely a fluke born out of its structure, and it serves as a reminder that exchange-traded notes might trade like ETFs, but they don't always behave like them. 

Premiums Spike In Tiny Note

INR provides exposure to the spot-exchange rate of U.S. dollars and Indian rupees, tracking an index of rolling three-month non-deliverable currency forwards.

Since its inception in 2008, INR has tracked its index well, but it has failed to gain much in the way of investor interest. It has only $1 million in assets and barely any volume day to day. (Its median daily share volume is 5. Yes, five shares.)

However, over the past few weeks, volume in the note has picked up again—so to speak—with roughly 25,000 shares traded daily since Sept. 6. At the same time, INR developed a substantial trading premium, climbing by double digits to where it is now, over 111%:

Source: ETF.com; data as of Sept. 26, 2019

Creations Halted, Premiums Develop

Spiking premiums likely comes back to the fact that although INR's creations were suspended in June 2015, it has never stopped trading. Indeed, shortly after the creation halt, Morgan Stanley, the issuer of the note, stated in INR's prospectus that it had $1.68 million of inventory that it could sell whenever it liked. 

Premiums and discounts arise over the course of normal trading in exchange-traded products, but usually, profit-minded authorized participants quickly arbitrage out any price discrepancies that may arise.

When exchange-traded products close to creations, however, they eliminate the ability of authorized participants to create new shares of that product. There's no pressure valve with which they can relieve the normal premiums and discounts that come up, and as such, trading premiums often develop and persist.

Of course, that is the case only as long as there is volume. And INR has barely seen any movement at all—until recently.

Why Is INR Being Traded Now?

INR's pickup in volume might stem from India's recent corporate tax cut, which could help buoy the exchange rate between the two countries.

Or it might have something to do with the fact that the note is set to mature next March.

ETNs mature like bonds; and when they do, investors receive a cash payment from the issuer equal in value to that of the underlying index, minus fees.

If INR is still trading at a substantial premium by then, investors in the fund would conceivably see a significant return on their principal. 

Path-Dependent Fee Structure

Except … there's one more thing about INR: Its fee structure varies widely depending on how well the note performs.

INR's expenses are path-dependent, meaning that instead of just multiplying the current assets under management by some pro-rated amount of the 0.55% expense ratio, the note instead charges a compound fee, calculated by multiplying the expense ratio times the principal amount times a daily “index factor,” based on the closing value of the index each day.

It's an old-school note structure that many modern ETNs have moved away from, but not INR. For investors, it means higher index values result in higher fees—and lower returns (read: "'OIL': An Oil Fund Doomed To Fail").

As such, INR's sky-high performance shouldn't be taken at face value. Investors in the note—however few there might be—are most assuredly not getting that 97% return.

Contact Lara Crigger at [email protected]