Leveraged ETF Closures Piling Up

Over the past two weeks, we've seen a bloodbath in leveraged and inverse exchange-traded products, with almost 30 ETFs and ETNs seeing the cessation of trading—sometimes overnight.

We've covered some of the closures as they've happened (read: "Why These Leveraged Energy ETPs Tanked" and "ETF & ETN Closures Spike In This Turmoil"). However, many more have shuttered as well.

All told, as of the time of this writing on March 23, 29 leveraged and inverse exchange-traded products had been delisted, closed or automatically accelerated; or their issuers had announced that they would be doing so soon.

Impacted funds and notes are summarized in the table below:

Sources: FactSet, issuer press releases, prospectuses; data as of March 23, 2020

Leveraged Products Uniquely At Risk

During periods of high market volatility, leveraged and inverse products are uniquely at risk of massive price swings that don't always match up to investor expectations.

That's because these funds don’t offer exposure to some multiplier of the total return of their underlying indexes, but rather offer exposure to some multiplier of the daily return of those indexes.

As a result, disparities between underlying index and ETP price quickly compound, even in highly trending markets, such as what we've seen lately.

This phenomenon is often mistaken for volatility, but it's really path dependence that makes leveraged and inverse funds diverge persistently from their underlying benchmarks. Note that leveraged and inverse ETFs can go haywire even in sideways, low-volatility markets.

For more on how the math of how leveraged/inverse ETFs work, read "Don't Buy & Hold Leveraged ETFs" and "The Truth About Leveraged ETF Returns."

What Is A Mandatory Redemption?

Over the past two weeks, the vast majority of ETNs that had closed had experienced a "mandatory redemption." That means the issuer was being forced—via the clauses set forth in the prospectus—to redeem the note early, before its intended closure date.

Most of these ETNs weren't intended to be closed for another two decades or more.

A mandatory redemption triggers when, during open market hours, an ETN's price falls below some minimum indicative value. Generally, this minimum indicative value is expressed as some percentage drop (e.g., 60%) below the previous closing price or, in the case of many of UBS’ ETNs, the previous monthly valuation.

Sometimes, however, the minimum indicative value is expressed in dollar per share terms. For example, some of UBS’ ETNs experienced mandatory redemptions because their intraday indicative values had fallen below $5.00/share.

If the minimum indicative value is struck, the issuer must automatically accelerate the ETN (meaning, move up the closure date from when it was previously scheduled) and pay investors some amount of cash called the "acceleration amount."

If this occurs, investors shouldn't expect to get their entire investment back, or even most of it. The acceleration amount—which is based on the much-reduced NAV the note struck that triggered the redemption in the first place and other inputs—is also net of fees.  

Elective vs. Mandatory Redemption

Some issuers, however, are redeeming their ETNs not because they're being forced to, but at their own discretion.

For example, Citigroup is choosing to redeem its popular VelocityShares 3x Long Crude Oil ETN (UWT) and VelocityShares 3x Inverse Crude Oil ETN (DWT), after UWT fell precipitously last week.

Elective redemptions tend to offer slightly more favorable terms for investors. Rather than the redemption amount being based on some cratering indicative value that triggered an automatic acceleration, UWT’s and DWT's redemption amounts will be based on their values over a five-day unwinding period.

However, not all elective redemptions feature such an unwinding period. UBS is also choosing to redeem its ETRACS - ProShares Daily 3x Inverse Crude ETN (WTID), after the note triggered a "stop loss termination" event on March 20, where its value felt below 30% of the current principal.

WTID investors will receive the March 20 closing principal amount on or around March 26.

ProShares is also closing six funds, or three pairs of up-and-down ETFs designed to provide 3x and -3x exposure to their underlying indexes.

The funds will close to new creations on March 27, then cease trading on March 30.

Investors can expect to receive their liquidation amounts on or around April 3.

Delisting: Worst Possible Option

As painful as a mandatory redemption clause is, it's actually an investor protection designed to prevent further losses from occurring. At least investors can rest assured they will receive some, though by no means all, of their money back on the redemption date.

That won't happen for exchange-traded products that have been automatically delisted, however.

Delisting occurs when an ETF or an ETN falls below the minimum share price required by the exchange. Should that occur, the product is automatically taken off the exchange; no more trades can be executed in it, except via over-the-counter markets.

The fund isn't closed, however; thus, investors are left stuck with extremely hard-to-liquidate positions. Conceivably, investors could liquidate their positions over-the-counter, but that can be difficult and expensive for retail investors to execute.

Two of the first casualties of this recent market volatility were two delisted ETNs: the iPath US Treasury Long Bond Bear ETN (DLBS) and the iPath US Treasury 10-year Bear ETN (DTYS).

Both ETNs’  indicative values had fallen below the minimum share price—and in fact had touched $0/share.

Contact Lara Crigger at [email protected]