ProShares, a leading issuer of leveraged ETFs, launched one of the last new ETFs of 2010 when it debuted the RAFI Long/Short (RALS) in December. Now the company has launched the first new ETFs of 2011, rolling out two volatility products on Tuesday. The ProShares VIX Short-Term Futures (VIXY) and VIX Mid-Term Futures (VIXM) are the first products to offer exposure to volatility in ETF form. VIXY will seek to replicate the performance of the S&P 500 VIX Short-Term Futures Index, which targets a weighted average term of one month. VIXM will seek to replicate the S&P 500 VIX Mid-Term Futures Index, which targets a weighted average maturity of five months [see 50+ All-ETF Model Portfolios].
The CBOE Volatility Index, also known as the VIX, is a well-known measure of the expected short-term volatility of the S&P 500 Index. The VIX is sometimes referred to as the “fear index,” reflecting its tendency to spike when anxiety over the U.S. economy is running high (it reached an all-time high in late 2008 during the worst of the financial crisis). As such, exposure to the VIX has appeal to investors looking for an asset that will maintain a strong inverse relationship to equity markets; the correlation between the VIX and the S&P is often close to -1.0.
Because the magnitude of the actual VIX index is computed using the prices of certain put and call options, a direct investment in the index isn’t possible. But innovations over the last few years have allowed investors to gain exposure to a new asset class known as volatility; futures linked to the VIX debuted in 2004, and options in the VIX began trading in 2006. The rise of the ETF industry has further democratized the asset class, as the first exchange-traded products linked to indexes comprised of VIX futures debuted in early 2009. In the two years since, more than a dozen additional VIX-related products have debuted [see VIX ETPs: Breaking Down All The Options].
Like all futures-based products, VIX ETPs depend not only on the change in the underlying asset (in this case, the VIX), but also on the slope of the futures curve. Generally, the market for VIX futures is in steep contango, meaning that longer-dated contracts are more expensive than those approaching expiration. As a result, while VIX ETPs will exhibit a strong correlation with the spot VIX, the performance over extended periods of time may deviate from the hypothetical “spot return” on the index. In 2010, for example, the VIX was down about 18%–roughly the amount gained by the S&P 500. The iPath Short-Term VIX Futures ETN (VXX), which offers exposure to a daily rolling long position in the first and second month VIX futures contracts, lost more than 70% on the year [see Free 7 Simple & Cheap All-ETF Portfolios].
First VIX ETFs
With the introduction of VIXY and VIXM, there are now 14 exchange-traded products in the Volatility ETFdb Category–all but two of which have debuted over the last year. But VIXY and VIXM become the first ETFs to offer exposure to VIX-related products; all previous products have been structured as exchange-traded notes. “Until now, to access volatility, many investors have considered exchange traded notes (ETNs), which subject them to the credit risk of the note’s issuer,” said Michael L. Sapir, Chairman and CEO of ProShare Capital Management, in a press release. “Now, for the first time, investors can access volatility with a U.S. exchange traded fund.”
ETNs are debt securities whose performance is linked to the change in an underlying index. While the ETN structure can eliminate tracking error, it also exposes investors to a certain degree of credit risk; if the issuing institution goes under, investors in the ETN get in line with the rest of the creditors–as those with assets in Lehman Brothers ETNs learned in 2008.
Aggregate assets in this ETFdb Category now top $2 billion, reflecting considerable interest among investors in adding volatility to their portfolios or using these securities as hedging tools as a part of more complex strategies. With expense ratios of 0.85%, the new ETFs from ProShares will be the cheapest options for volatility exposure; the ETNs with which they will compete most directly–VXX and VXZ–both charge 0.89%.
Alternative ETF Push
Many investors associate ProShares with leveraged ETFs; total assets in the company’s leveraged products are close to $25 billion. But in recent months ProShares has stepped up efforts to build out its non-leveraged product suite, billing itself as the “Alternative ETF Company.” Last month saw the debut of RALS, a long/short product that utilizes the popular RAFI methodology to determine weightings given to large cap stocks [see Under The Hood of The New RAFI ETF]. ProShares also offers the only 130/30 ETF available to U.S. investors; the Credit Suisse 130/30 (CSM) uses a quant-based methodology to construct a net 100% long portfolio that aims to beat the S&P 500 [see How The 130/30 ETF Works].
Disclosure: No positions at time of writing.