Tag Archives: alternative

5 Lessons Learned From VIX ETFs

The CBOE VIX Volatility Index is an interesting animal that has grown to become one of the most heavily watched indicators of fear and greed in the market. There are currently 20 dedicated exchange-traded funds and exchange-traded notes that attempt to track this index with varying degrees of success. By their nature, VIX funds are a non-correlated index that is essentially a way to measure when the stock market starts to get shaky. The CBOE VIX Volatility Index is an interesting animal that has grown to become one of the most heavily watched indicators of fear and greed in the market. This index functions by measuring near-term volatility expectations from options activity on the S&P 500 Index. It’s calculated on an intra-day basis, so investors are able to watch as implied volatility expands or contracts in real time. The CBOE has a nice primer on how this is accomplished that you can read here . As many ETF investors know, you can’t invest directly in an index. So the forward-thinking asset managers at Barclays, ProShares, and VelocityShares set out to create several products to help you invest in the movement of the VIX Index. According to data from ETF.com, there are currently 20 dedicated exchange-traded funds and exchange-traded notes that attempt to track this index with varying degrees of success. The two largest funds in this space are the iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA: VXX ) and VelocityShares Daily Inverse VIX Short Term ETN (NASDAQ: XIV ). Both of these funds currently have over $1 billion in assets under management. VXX is a bet on the expansion of volatility, which typically comes during a correction or choppy stock market action. Conversely, XIV is an inverse play that rises when volatility contracts. This fund is intended to move higher as stocks move higher and greed takes a more prominent position in investor sentiment. There are also many other flavors of VIX funds that offer varying degrees of unique tracking and index construction methodology. Nevertheless, XIV and VXX work well as benchmarks to understand this unconventional asset class. I have been watching and even invested small amounts in these funds for my personal accounts at one point or another and these are the lessons I have learned from the experience. They aren’t for the faint of heart. By their nature, VIX funds are a non-correlated index that is essentially a way to measure when the stock market starts to get shaky. It’s difficult to use these as a forecasting tool and they are often susceptible to VERY fast swings in price . They should truly only be used by disciplined traders, investment professionals, or those who understand their unconventional nature. In my opinion, they should only be held for very short periods of time with a tight stop loss to guard against significant downside risk. They don’t track all that well. These VIX funds work by tracking futures contracts similar to a commodity fund like oil or natural gas. That in itself causes problems in accurate price movement over long periods of time as complicated forces like contract rolls, contango, and expenses work against these products. The chart below depicts an overlay of the actual CBOE VIX Volatility Index and VXX. The movements are certainly correlated to a degree, but you can see how over time the price of the exchange-traded product continues to decay versus the spot price of the index. They aren’t cheap. The listed annual expense ratio of VXX is 0.89% and XIV is 1.35%. It should be expected that a fund investing in futures contracts will naturally generate higher expenses because of the complicated nature of the process. Nevertheless, it’s important to understand that these funds are going to eat into your pocketbook as well. Some come with tax headaches. Most of the investable VIX funds are structured as exchange-traded notes, which do not experience adverse tax consequences. However, if the fund is structured as an exchange-traded fund, it may be susceptible to tax consequences in the form of a K-1 that must be accounted for as well. The K-1 is generated because you are participating as a shareholder in a partnership rather than a trust. It goes without saying that you carefully read the prospectus before investing in any of these funds. They are entertaining to watch. Regardless of whether you use these vehicles, they can be entertaining to watch and also offer some insight into the market’s fickle machinations. VIX ETNs allow individual investors the ability to monitor in real time the current sentiment towards stocks and may provide a piece of the puzzle for short-term traders. They also offer a technical dynamic that may be useful for investors who are fans of relative strength or other momentum indicators. Sharp inflection points in the VIX may point towards a turning point in the market that precedes a big move (up or down). The bottom line is that these products are primarily geared for advanced users with a high tolerance for risk and sophisticated knowledge of the markets. Those that choose to dabble in these funds should only do so with a well-defined risk management plan that protects your capital in the event of a reversal.

IMF Green Signal Put Yuan ETFs In Focus

The Chinese economy is telling us two different stories at a time. While on one hand, the economy is persistently delivering offhand economic numbers, and even raised hard landing fears at some point of time, on the other, its currency – yuan – received a privileged reserve status from the International Monetary Fund (IMF) recently. Notably, the inclusion of the yuan in the IMF’s reserve currency list gives the economy a cream-of-the-crop class, as this emerging currency will now sit beside the developed currencies like the U.S. dollar, pound, euro and yen. Also, the IMF nod indicates economic stability in China. The IMF’s executive board, which represents the fund’s 188 member nations, recently settled on the fact that the yuan now enjoys a “freely usable” status. The move marked the first change in the SDR’s currency portfolio since 1999, per Bloomberg . Not only this, China’s currency will have a weight of 10.92%, higher than that of the yen (8.33%) and the pound (8.09%), but lower than the euro (37.4%) and the U.S. dollar (41.9%) weight. The move will take effect in October 2016. Why the Move? Though several theories are doing rounds right now, both positive and negative, the IMF viewed it as the consequence of reformative measures presently being undertaken in China. However, one school of analysts addressed the decision as “political,” and is not counting on the easy accessibility of the currency, because the yuan cannot be transferred into other currencies without restrictions. The believer of this school also indicated that the IMF head “realized how bad things are in China, so what she (Christine Lagarde) decided to do was to throw China a lifeline.” This way, the IMF boss can press the Chinese government to launch a total convertibility for its currency. Notably, the Chinese economy is on its way to deliver a 25-year low expansion this year. Despite the roll-out of a flurry of measures, the economy has showed no signs of a steady recovery, and the financial markets remained highly volatile due to extreme risk-taking. Investors should also note that movements in the yuan market have been rampant this year. In August, China’s central bank devalued the currency by 2%, following which yuan posted the largest single-day decline since the historical devaluation in 1994, after the country arranged its official and market rates in a line. Notably, the Chinese authorities follow a trading band around the official reference rate it sets each day for the value of the yuan against the dollar. The Chinese government announced in August that the renminbi’s central parity rate would follow the previous day’s closing spot rates more closely going forward. This indicates China’s intent to make its currency more market-driven. As a result, a section of analysts believe that the actual motive behind this currency move was to prepare the yuan as a reserve currency. Most importantly, the Chinese central bank assured the market that it would promptly intervene in the currency market if depreciation crosses the 3% mark. Busy Trading in Yuan The yuan became the fifth-most active currency for global payments by value in October, with a market share of 1.92%, per the global transaction services organization SWIFT . Not only this, the Chinese currency beat the Hong Kong dollar and the U.S. dollar for payments between Japan and China/Hong Kong in October. Standard Chartered and AXA Insurance estimate that the IMF’s green signal will offer the yuan a minimum of $1 trillion of movement. Needless to say, this historic move makes it important to look at the Chinese yuan ETFs. WisdomTree Chinese Yuan ETF (NYSEARCA: CYB ) The most popular Chinese yuan fund is CYB from WisdomTree. The product invests in short-term, investment-grade instruments in order to be reflective of both money market rates in China available to foreign investors and changes in the value of the yuan against the dollar. The product charges investors 45 basis points a year, but sees decent average volumes of 50,000 shares a day on AUM of over $64.4 million. The fund currently has a Zacks ETF Rank #3 (Hold) with a Low risk outlook. It is down over 1.2% so far this year (as of December 1, 2015). Market Vectors Chinese Renminbi/USD ETN (NYSEARCA: CNY ) For investors seeking an ETN way to target the Chinese currency, CNY is the right option. This product tracks the S&P Chinese Renminbi Total Return Index, which looks to track the performance of the Chinese currency against the U.S. dollar, by rolling three-month non-deliverable currency forward contracts. The fee is a bit higher at 55 basis points a year, while volume comes in below 5,000 shares a day, suggesting a wide bid-ask spread and ever-increasing total costs. The product is down 0.6% so far this year. The ETN currently has a Zacks ETF Rank #3. CurrencyShares Chinese Renminbi Trust ETF (NYSEARCA: FXCH ) This product looks to track the price of the Chinese renminbi net of Trust expenses. The product has amassed about $7.7 million in assets, while it sees weak volumes of around 1,000 shares a day, suggesting a wide bid-ask spread. On the positive side, the ETF has the lowest expense ratio at just 40 basis points a year in the Chinese currency ETF space. The fund has lost 2.7% this year and carries a Zacks ETF Rank #3. Original Post

CET: An Out Of Step Old Timer That’s On Sale

Central Securities Corp. is one of the oldest closed-end funds around. It sticks to a value focus, which has kept it out of sync with the broader market of late. But with an around 20% discount, it might be worth a look for patient investors. Central Securities Corp. (NYSEMKT: CET ) is one of those closed-end funds, or CEFs, that kind of gets lost in the crowd. It hasn’t been a standout performer lately and what it does is, well, kind of boring. But for a long-term investor seeking a value fund it might be just the kind of boring you’ll like since it’s trading at an around 20% discount. Value versus growth There are two broad camps in the investing world, value and growth. There’s a lot of wiggle room in there, but it can be interesting to compare the two broad-based approaches. For example, since the bottom of the market was reached during the deep 2007 to 2009 recession, the Vanguard Growth ETF (NYSEARCA: VUG ) had handily outdistanced the Vanguard Value ETF (NYSEARCA: VTV ). VUG data by YCharts That’s not so surprising in hindsight, but it provides an important backdrop for research. If you are looking at a growth-focused CEF and comparing it to the market, it will probably look good. If you are looking at a value-focused CEF, well, not so much. Which is where Central Securities comes in. CET is a value fund and, perhaps, worse, it likes to own securities for a long time-which means it isn’t likely to switch into today’s hot stocks to follow the lemmings or to window dress its portfolio. In other words, when Central Securities is out of step with the market, it can look like a lousy investment option. But long-term performance suggests it isn’t. For example, the CEF’s trailing annualized 25-year return through December 2014 was around 12% compared to 9.5% for the S&P 500 Index, according to the fund. It held a similar, though not quite as large, edge over the trailing 20-year period, too. Over shorter periods, however, it has generally lagged. For example, over the trailing 1-, 3-, 5-, 10-, and 15-year periods through October Central Securities lags the broader market. The shortfall narrows materially the further back you go. For example, over the trailing 15 years, Central Securities’ annualized net asset value total return, which includes reinvestment of distributions, was roughly 4%. Over that same span the S&P’s total return was 4.5% or so. Over the trailing year through October, however, Central Securities was down roughly 1% while the S&P was up about 5%. Percentage wise, that’s a huge rift. But the backdrop is critical. VUG and VTV offer up a similar disparity. So, in some ways, Central Securities is doing what you’d expect. Moreover, leading into 2000, roughly 15 years ago, the market has been dominated by cycles of boom and bust. We are currently in an up cycle, in my opinion, highlighted once again by tech darlings sporting extreme valuations. In other words, not much has changed since the turn of the century. And that’s left a closed-end fund like Central Securities out of step. The long, long term But the thing to keep in mind about Central Securities is that it’s been in business since 1929. So it doesn’t think in days, months, or years. It thinks in decades… or longer. For example, three of its top-10 positions were purchased in the 1980s and one was bought in the 1990s. Yet another was added in 2000. That doesn’t mean it won’t buy and sell stocks when it sees opportunities, but when it buys a company it often holds for a long time (the other half of the top 10 were purchased in 2007 or later). Such long holding periods are not the norm in the fund world. So, almost by design, Central Securities is out of step. According to the fund : Our approach is to own companies that we know and understand, which we believe reduces risk. We also consider the integrity of management to be of paramount importance. We try to find new investments available at a reasonable price in relation to probable and potential intrinsic value over a period of years into the future and then hold them through the inevitable market ups and downs. If you think that sounds like something you’d expect out of Warren Buffett’s mouth, you’d be right. So why now? The interesting thing about Central Securities right now is its nearly 20% discount to net asset value. That’s fairly wide for this fund, which has a 10-year average discount closer to 16%, according to the Closed-End Fund Association-a level at which it traded when I last looked at the fund earlier this year. If you look back over the fund’s history on a quarterly basis 20% is a relatively infrequent number to see. Which helps explain why the fund repurchased roughly 775,000 shares through the first nine months of the year. The average price on those purchases was around $21. Central Securities’ shares have recently been trading hands below $20. If you are looking for a value-focused fund with a long-term history of success, this might be a good option for you. Just be prepared to hold for a long time and to handle being out of step with the market for sometimes lengthy periods. But when value comes back into favor, which history suggests it will, this fund’s willingness to stick to its knitting should shine through. The caveats But that doesn’t mean it’s right for everyone. For starters, if you are an income investor, the fund only pays semi-annually. And the distribution has varied greatly over time. So you can’t really count on Central Securities for income. It does have a lot of unrealized capital gains in the portfolio, which isn’t surprising given its penchant for owning stocks for long periods of time. However, that doesn’t mean it will sell them just to fund a distribution, only that it could do so if it wanted. Another wrinkle here is that the CEF’s largest holding is The Plymouth Rock Company, a non-traded insurance company. That one position makes up nearly 20% of the portfolio. That means management is pricing a huge chunk of the portfolio by itself. It has a system in place for that, but Central Securities does not own a diversified portfolio. It’s worth noting that The Plymouth Rock Company has been actively buying back its shares. Central Securities, for example, sold 6,000 shares in the third quarter, leaving it with over 28,400 shares worth a total of $109 million at the end of the quarter. CET has a massive unrealized gain in this one investment, since the initial cost was only about $700,000. Which helps explain why Central Securities has pretty much told The Plymouth Rock Company that it is willing to sell, but only a little at a time and only if the price is right. So this issue is likely to get smaller as time goes on. (A shout out to Papaone for digging that nugget out of a Plymouth Rock report.) Whether or not a concentrated portfolio and difficult to gauge dividends are reasons to bypass Central Securities is really going to be based on your investment preferences. But I would say conservative income-focused investors would probably be best off looking elsewhere if you are trying to replace a paycheck. However, Central Securities is well worth a deep dive if you are looking for a value-focused fund that has proven it won’t change its stripes and see the income it throws off as a side benefit and not the main show.