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Is XIV The Place To Be If Markets Stabilize And Volatility Declines?

Summary This large ETN is close to its year low and has lost 43% over the past year. As a play on a quiet fall market, is there money to be made when the VIX goes lower? We do an analysis of this heavily traded ETN and answer these questions and more. The VelocityShares Daily Inverse VIX Short-Term ETN (NASDAQ: XIV ) is a rather simplistic (on the surface) security to take advantage of a fall in volatility. According to the sponsor, VelocityShares, The ETNs are medium-term notes of Credit Suisse AG (“Credit Suisse”), the return on which is linked to the performance of either the S&P 500 VIX Short-Term Futures™ Index ER or the S&P 500 VIX Mid-Term Futures™ Index ER (each such index, an “Index” and collectively the “Indices”) The ETNs do have a maturity date of December 04, 2030 but for all intents of purposes the maturity only represents a future date for the instrument to be redeemed or perhaps extended. The ETNs pay no interest and there may or may not be a return of principal upon maturity. A majority of investors in this ETF use the vehicle to hedge against lower volatility. The turnover of only 2 days is indicative of this factor. We will analyze the basic structure and provide some of the key risk factors of this instrument that has seen a significant inflow of funds over the past month. A recent overall structure was quite simplistic: XIV Structure, as of September 10 Contract name Weight CBOE Short-term VIX Future Sept 2015 17.00% CBOE Short-term VIX Future Oct 2015 83.00% As noted, with only 17.00% of the futures contract focused on September, the balance now shifted to October one has an opportunity to participate in lower volatility. The underlying question is, is it that simple? Simply by waiting five days we find it is hardly that simple. Here is the revised structure five days later: XIV Structure, as of September 15 Contract Name Weight CBOE Short-term VIX Future Oct 2015 100% The October contract closed at 23.85 on September 10 and at 20.425 on September 15. All contracts from September have now been rolled over to the current month. As many analysts have stated simply the way VIX contracts are priced, investors will gain approximately 5.00% or more a month on the roll-over. This sounds fantastic and would appear to be a simple way to pick up a very nice return. There are multiple issues why this is not that easy or simple. Since this ETF functions as an inverse to the S&P 500 VIX and is really a short vehicle for the VIX in an ETN form the fund managers in Switzerland via their model and the prospectus must buy contracts that are about to expire and sell the next month. This would be defined as a contango strategy. As such, as noted, XIV may very well gain 5% or more per month simply by rolling future contracts (buying back the ones that are about to expire and sell the next month. The ETN must maintain a short position and bias at all times. The only problem is that not only will the fund lose money during market corrections but also when markets move sideways. These sideway moves occur during political gridlock, holiday periods, Federal Reserve indecision, economic malaise, and during electoral seasons, (in general) to name a few. One of the other problems is that the daily indicative value may be higher or lower than the closing price. As such, an investor can go to sleep believing they could not possibly lose money since the market is rallying overseas, while in fact they lose $.50 per share upon market opening. Fortunately, the share price over time has outperformed the indicative prices and the NAV. Presently the indicative price is $28.08 versus a closing price of $27.75 on September 15, according to Velocity Shares. The one month premium average to the NAV or indicative price has been .78%, reflecting the recent market correction. Many times, (including the presently) it trades at a discount. In terms of the market correction, here are some historical prices and percentage changes on XIV and since August 01 (using XIV closing prices and VIX settlement prices): Date XIV Price C hange Percentage Change VIX Futures Prices Sept/ Oct Change Percentage Change Aug 03, 2015 $48.76 NA NA 15.125 15.875 NA NA Sept 01, 2015 $22.01 -$26.75 -54.86% 29.725 25.825 14.60 9.95 96.52% 62.67% Sept 15, 2015 $27.75 -$21.01 $5.74 -43.08% 26.07% 22.575 20.425 7.45/-6.97 4.55/-5.40 49.25%/-23.46% 28.66%/-20.90% Note: The second numbers listed under change and percentage change are intermediate price changes, (since September 01). As noted above XIV has recouped 26.07% since September 01 and is climbing quickly as global markets settle down and rally, but is still down 43.08% since August 03. The October VIX has lost 20.90% since September 01, yet is still up 28.66% from August 01. Unfortunately, one cannot simply device a model or formula to determine the profit (or loss) potential when the VIX rallies or sells off versus the performance of the XIV. The best we can do is state a 1.24-1.50% correlation between the two. In other words when the VIX rallies an investor should loss approximately $1.25 for every dollar in XIV and when it falls gain approximately $1.50. This is not an exact mathematical formula but simply based upon our own correlation analysis. There are simply too many variables that influence the price action for this correlation to be valid over a significant period of time and further analysis is necessary. Investors should also be aware that the ETN has a net expense ratio of 1.35% versus a category average of 1.27%. In addition, the beta of the ETN is -.90 and the Alpha is -1.7 for the past three years. This is obviously almost a total negative correlation to the S&P 500, but not 100% or a perfect -1.00. A recent article in Barrons stated traders have shunned the ETN this month. Investors placed $345.00M in the ETN in late August, while have only put in $18.9M since September 03. The ETN presently has 1.48BLN market capitalization. The Barrons’ writer should have analyzed further why this is so. One way is to review the holdings of the ETN. Yes, many trader’s use this vehicle as a speculative tool. Predominately, there are large funds and institutions that have placed substantial funds in the ETN as a hedge vehicle for their pension and other large institutional investors. For example, Lazard Capital has a particular fondness or appetite for the vehicle, owning 72,250 shares or 1.76% in one of their Institutional Funds. In addition, Credit Suisse (NYSE: CS ) holds a 26.453% stake, UBS (NYSE: UBS ) 6.46%, and Citigroup (NYSE: C ) holds 3.42%, among other firms. Overall, institutions own approximately 74.04%, with mutual funds hold only .49%, according to Fidelity.com. As such, these institutions are not so much traders as they are hedgers. These investors are simply holding at this time and not adding to their position or selling. They have already placed their hedge for the next quarter. As such, they are using it as a vehicle for their overall holdings to take advantage of lower volatility and add “alpha,” without having to directly go to the futures market. In addition, there are many hedge funds that are using the vehicle to take advantage of a decline in volatility going forward. As a retail investor we feel that an investor may participate with the institutions but only with a portion of assets and on a strictly month to month basis. This is our primary reason in analyzed this ETF since August 01. Since the beginning of the year XIV is down 12.05%, but -44.61% since June 24 when it hit a price of $50.10. It is fruitless as a retail investor to use this ETN as a long term investment vehicle. A quarter to quarter investment or hedging tool to take advantage of calming markets and lower volatility is fine. Unfortunately, we would not recommend this vehicle as a long term, let alone cyclical type investment vehicle. The risks are simply too high as a buy and hold investment. Take advantage of the higher volatility, pick up a quick return of possibly 10% riding the wave of lower volatility, but don’t overstay the party. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Additional information and analysis is from velocitysharesetns.com, morningstar.com, fidelity.com, yahoofinance.com, tdameritrade.ca, cboe.com, and our own analysis.

3 Mutual Funds To Buy If Fed Opts For Rate Hike

In our Mutual Fund Commentary yesterday we spoke about funds in focus if the U.S. Fed decided against a rate hike as soon as September. Utilities funds demand attention then as low interest rate environment, which has for sometime been near a zero level, has been extremely conducive for its growth. The capital intensive utilities industry needs to access external sources of funds to expand its operations. While it remains too close to call, today let’s look at funds that investors may immediately add to their portfolios if the Fed announces rate hike. Amid the market volatility, the Fed seems to be stuck between global central banks’ easing measures, dollar strengthening, deflationary pressures arising from the energy sector and troubles in the global economy. While most polls recently turned against a September rate hike, a recent CNBC survey shows that 49% predict a rate hike now. We do not rule away the chances of a rate hike completely, may be by 0.25%, but uncertainty is what is ruling the roost. Whether lifting the monetary policy stimulus would be a prudent move is the question that the Fed needs to answer. The two-day Federal Open Market Committee’s policy meeting ends today. The finance sector, in this regard, seems to be a good bet, as several industries including insurance, banking, brokerage and asset managers tend to benefit from the rising rates. Before we pick the funds, let’s look at some other details. CNBC Survey Goes Against Other Polls According to a CNBC survey, 49% of respondents out of 51 economists are projecting a rate rise now. This data as of Sep 16 is in line with predictions on Aug 25. On the other hand, those believing in a delayed rate hike dropped to 43% from 47% on Aug 25. The rate has increased for those who are unsure, as the percentage is at 8% as of Sep 16 compared with 5% on Aug 25. They predict that the Fed will finish hiking rate in this cycle, or take it to “terminal rate” in the first quarter 2018. This brings the prediction forward by six months. Separately, most are of the view that markets have priced in the hike. While 56% believed its priced into stocks, 60% said its priced into bonds. However, the Standard & Poor’s 500 is estimated to finish 2015 at 2,032, lower that prior projection of 2,135. Meanwhile, a Reuters poll shows that 45 respondents out of 80 economists believe that the Fed will leave its benchmark interest rate between zero and 0.25%. Only 35 respondents expected a rate rise. Looking at the primary dealers or economists from banks dealing directly with the Fed, 12 banks see no rate hike now as against 10 expecting a rate hike. Financials to Gain While Deutsche Bank believes they expect a “hawkish hold,” stance, UBS chairman Axel Weber is expecting a rate hike. He said: “The underlying economic data in the U.S. warrants a rate hike. The U.S economy can stand it. The U.S. economy in my view actually needs it medium- to long-term and I’m pretty convinced that the U.S. will see a rate hike, most likely in September.” The financial sector will be among those which will gain if a rate hike occurs. One particular beneficiary of higher rates is the insurance industry. This is because they take in premiums from customers, invest them — usually in fixed income securities — and then pay out claims in the future. Also, brokerages earn interest income on un-invested cash in customer accounts. So when rates rise, they can invest this cash at higher rates. Banks may benefit from rising interest rates, as long as long-term rates move up more than short-term rates. Banks derive benefits from a steep yield curve, i.e. when the spread between long-term and short-term rates is wide. The interest rates on deposits are usually tied to short-term rates while loans are often tied to long-term rates. This means that the potential rise in rates will enable the banks to charge more for loans, leading to an increase in the spread between lending rates and the rates paid on deposits. Moreover, an improving economy means that credit quality will likely improve, which will also aid banks’ profitability. Insurance companies invest majority of the premium income received from policyholders in government and corporate bonds to earn investment income. They utilize this investment income in meeting their future commitments to policy holders. The potential rise in rates will allow the insurance firms to invest their new premium income in higher yielding securities, thereby leading to higher future returns. With a rise in rates, brokerage firms are likely to engage in more investment activity. Brokerage firms earn interest income on un-invested cash in customer accounts. The rise in rates will allow the brokerage firms to invest at higher rates. Further, asset managers can position themselves favorably with the rise in rates. In the fixed income sector, default rates are likely to decline and higher interest rates will enable reinvestment at higher yields, which ultimately will boost portfolio returns. The benefit can be achieved by positioning fixed income portfolios strategically through proper management of duration, diversification of sources of yield and maximize the reinvestment of income. 3 Financial Mutual Funds to Buy Below we present 3 Financial mutual funds that carry either a Zacks Mutual Fund Rank #1 (Strong Buy) or Zacks Mutual Fund Rank #2 (Buy). We expect the funds to outperform its peers in the future. Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but the likely future success of the fund. The funds have encouraging year-to-date, 1-year and 3 and 5-year annualized returns. The minimum initial investment is within $5000. These funds also have low expense ratio and carry no sales load. Emerald Banking and Finance Fund A (MUTF: HSSAX ) seeks long-term growth through capital appreciation. Income is a secondary objective. HSSAX generally invests at least 80% of its net assets in common stocks. Emerald Banking and Finance’s managers limit the fund investment to 50 companies and the fund invests primarily in U.S. based companies. HSSAX currently carries a Zacks Mutual Fund Rank #2. It boasts year-to-date and 1-year returns of 11.9% and 18.3%. The 3 and 5 year annualized returns are 20.1% and 18%. Annual expense ratio of 1.60% is however higher than the category average of 1.52%. Moreover, HSSAX also has low beta score. The 1, 3 and 5 year beta scores are 0.58, 0.63 and 0.75. Franklin Mutual Financial Services Fund A (MUTF: TFSIX ) seeks capital growth. TFSIX invests a lion’s share of its assets in undervalued companies that are involved in the financial services domain. TFSIX may also invest in merger arbitrage securities and securities of distressed companies. TFSIX currently carries a Zacks Mutual Fund Rank #2. It boasts year-to-date and 1-year returns of 4% and 7.3%. The 3 and 5 year annualized returns are 13.9% and 11.2%. Annual expense ratio of 1.44% is lower than the category average of 1.52%. Moreover, TFSIX has 1, 3 and 5 year beta scores of 0.81, 0.83 and 0.70. John Hancock Regional Bank Fund B (MUTF: FRBFX ) invests most of its assets in equities of regional banks and lending companies. These may include commercial banks, industrial banks, savings and loan associations, financial holding companies, and bank holding companies. FRBFX may also invest in other U.S. and foreign financial services companies. A maximum of 5% may be invested in stocks outside the financial services domain. FRBFX currently carries a Zacks Mutual Fund Rank #2. It has year-to-date and 1-year returns of 2.2% and 8%. The 3 and 5 year annualized returns are 14.3% and 13.2%. Annual expense ratio of 1.98% is however higher than the category average of 1.52%. Moreover, FRBFX has 1, 3 and 5 year beta scores of 0.62, 0.65 and 0.88. Link to the original article on Zacks.com

Fund Watch: Balter And Natixis/ASG Prep New Funds

By DailyAlts Staff In this edition of Fund Watch, new fund filings for: Balter European L/S Small Cap Fund ASG Dynamic Allocation Fund Balter European L/S Small Cap Fund On September 15, Balter Liquid Alternatives filed a Form N-1A with the Securities and Exchange Commission (“SEC”) announcing its intent to launch its third mutual fund , the Balter European L/S Small Cap Fund. As is evident by its name, the new fund will take both long and short positions in small-cap European stocks, in pursuit of its objective of absolute returns. The fund is the successor to the S.W. Mitchell Small Cap European Fund, a hedge fund, which will transfer its assets to the institutional shares of the new fund upon its launch. S.W. Mitchell Capital LLP will continue to manage the fund as the sub-advisor. Typically, the Balter European L/S Small Cap Fund’s portfolio will consist of roughly 60 such stock positions, which may include both listed and non-listed equities; and the fund’s managers can also invest in debt securities, options, warrants, convertibles, and other derivatives. Its net-long exposure can be as great as 150%, and while its net-short exposure could rise to as much as 50%. The fund will have short positions at all times. The Balter European L/S Small Cap Fund’s predecessor fund has performance dating back to 2008. Its shares returned -6.5% that year, but then posted successive annual gains of 44.6% and 23.8% in 2009 and 2010. After losing 7.7% in 2011, the fund roared back with successive gains of 11.1% and 24.8% in 2012 and ’13, and then returned -0.5% last year. Shares of the new fund will be available in institutional and investor classes, with respective net-expense ratios of 2.24% and 2.54%. ASG Dynamic Allocation Fund Natixis Funds Trust II recently filed a Form N-1A with the SEC, announcing its plan to launch the ASG Dynamic Allocation Fund. The new fund’s objective will be long-term capital appreciation, with the protection of capital during unfavorable market conditions a secondary goal. It will pursue this end by means of dynamic tactical allocation across global markets and asset classes, overseen by investment advisor AlphaSimplex Group’s portfolio managers Alexander Healy, Robert Rickard, and Derek Schug. Healy, Rickard, and Schug will also be charged with the task of managing the fund’s annualized volatility, which is targeted at no more than 20%, as measured by the standard deviation of the fund’s returns. The fund will also use leverage, which will not exceed 200% of assets. Currently, ASG operates nine alternative mutual funds , including the ASG Global Macro Fund (MUTF: GMFAX ), which was launched in partnership with Natixis . That fund, which debuted on December 1, 2014, returned -3.45% in the first eight months of 2015, ranking in the bottom quintile of funds in its category. Over the three months ending August 31, the fund’s performance was better, in the top quartile, but still negative at -2.03%.