The vibe of the IndexUniverse’s InsideETFs Conference in Hollywood Florida I attended in 2012 was one that I have felt before—a group that knows they’re changing the very structure of their industry. It’s not just about being new, creative, or disruptive—it’s the sense of knowing you have won.
The mutual fund industry is still almost 10 times the size of ETFs/ETNs with $7.9 trillion in assets vs $1.0 trillion, but their size isn’t giving them economies of scale in terms of fees or performance. According to Matt Hougan, President of ETF Analytics, IndexUniverse the weighted fee cost of mutual funds is 0.83% of assets, almost triple the 0.32% of ETFs. For mutual funds to become competitive on fees they would need to charge $40 billion less. With regards to performance, the numbers from 2011 indicate that 90% of the actively managed mutual funds underperformed their comparable passive indexes.
At the beginning of the end:
The last of the old dominant players start moving from denial to adoption.
- Fidelity has announced they will be offering a wide range of ETF products
- In March PIMCO will start offering TRXT, an actively managed ETF that will track their flagship Total Returns Mutual Fund
Products using the new technology achieve broad acceptance
- The SPY ETF has more than $100B in assets under management
Remaining structural/regulatory barriers to the new technology start falling
- Most 401K plans ($2.5 trillion in assets overall) do not offer ETF products, but because of ETF’s lower expense structures this will change.
The key benefits of the new technology are apparent to everyone
- ETFs have lower fees compared to the mutual funds with similar strategies
- The tax efficiency of ETFs is demonstrably superior, just 7.5% had capital gain payout in 2011
- ETFs trade throughout the day and their makeup is transparent to the buyer
- Alternative investment strategies are easier to implement (e.g., volatility as an asset class, risk on/off)
The old businesses still in denial will shift from data based arguments to fear
- ETFs are responsible for increased market volatility
- ETFs caused the flash crash
- The tax treatment of ETFs is uncertain
- ETFs short interest can exceed the shares the ETF has issued, leading to a potential collapse scenario
Just like the mainframe computer, the mutual fund will never die. Some investors will never see a reason to change, especially to something they don’t understand. Others will never buy due to fear—mutual funds have a history, unlike these new unproven things. But ultimately greed will lead most investors to overcome their fears, and mutual funds will join vacuum tubes as a technology has-been.
Vance,
Just thinking about the various ways of trying to take advantage of contango in the VIX and their drawbacks.
Maybe the most obvious way is simply to short VXX. Of course, that will probably work most of the time, but you take on a couple of risks – (1) the possibility of a relatively quick explosion in VXX of double, triple or more; and (2) the possibility of a forced buy-in (could be painful at the wrong time). Probably a winner most of the time, but it is going to be a big loser every once in a while.
Now you have the inverse ETFs – XIV, ZIV, IVO, XXV. On the upside, you don’t have the risk of losing multiple times your invested money, like with a VXX short. But, as you know, the daily resetting (XIV) can be a drag as can be the no resetting (XXV stuck with limited upside and IVO closing). Also, XIV can close as well with a big enough jump in VXX in a single day. Over a decades timeframe I think that will probably happen.
Given the above, I am wondering if there is a good way to make money on these and deal with the risk. I am thinking there are a few possibilities to consider: (1) XIV with a timing signal (say a simple moving average signal); XIV should do well in a upward trending market; (2) an addition/subtraction scheme with XIV – meaning you start with a certain amount in XIV and take money out as it gets over a certain amount and add money back in after the XIV goes down a certain amount (say 30% or 50% or something) – hopefully you sell high and buy low and take advantage of mean-reversion of VIX and the contango in VIX; (3) some type of bear spread option strategy with VXX.
Anyway, I think there are a couple other ways to go, but I am just thinking out loud here and wouldn’t mind hearing your thoughts.
Steve
I think you have to use some kind of moving average timing approach to XIV. Maybe a 40 or 50 day moving average.
It might be a good idea for a blog post, Vance: how have you traded XIV through the volatility spike of the last half year or so?
Vance,
By the way, I see that you made a reply to my comment on the GASZ/OILZ thread, but I am having trouble seeing it.
Hi Steve,
Thanks for pointing this out. My commenting system got flaky for a while when I did the latest WordPress upgrades. I have reposted my comment, but basically I noted that while the volumes are low on GASZ/OILZ their bid/ask spreads tend to be very reasonable.
– Vance
Hi Vance,
I believe that you did an earlier post on going short both VXX and XIV. I see that TVIX, VXX, VXZ, TVIZ, XIV and ZIV were all down for 2011 and wondered whether you had considered and tested other combinations of shorts for these. Given the inverse relationship of XIV and ZIV with the others, at first it seems like there would be a good method. However, I think in reality a trending VIX would blow the trade out of the water.
Hi Steve, Yes, I did do a VXX / XIV comparison: https://www.sixfigureinvesting.com/2011/11/pairs-trading-short-vxx-and-short-xiv/ I think these static pair combinations in general are fraught with problems. Pitting daily resetting funds, with their path dependencies, against funds that have variable leverage (e.g., IVOP), or strong mean reversion tendencies (VXX), and then mixing in contango/backwardation factors looks like an unprofitable mess to me. VelocityShares has done some very interesting work with mixes of 2X long plus a daily resetting inverse (http://tinyurl.com/7aaxz6p). I suspect they will productize this soon. It uses multiple resetting portfolios to address the path dependency problems. The other option I like is Barclays’ XVZ, which dynamically selects the mix of long/short investments based on the VIX/VXV.
– Vance
Well put on the note about investors eventually coming over for greed. Less fees and really a more simple, consumer driven vehicle that IS easy to understand once you get some basic education will lead more people to ETF’s. I would still stay away from the inverse ones though 🙂
Hi Nate,
Thanks. I think we are still looking for a good metaphor to explain the ETF share creation / redemption process. People do understand buying and selling stocks, but in-kind transfers aren’t part of our normal day-to-day transactions. Perhaps making change is the closest thing.
— Vance
Hi Nate,Thanks. I think we are still looking for a good metaphor to explain the ETF share creation / redemption process. People do understand buying and selling stocks, but in-kind transfers aren’t part of our normal day-to-day transactions. Perhaps making change is the closest thing.
– Vance