In February 2012 VelocityShares‘ TVIX ETN was on a tear. Its volume surged from an average of 6.67 million shares a day in January to 22 million shares a day in February. The assets under management (AUM) also grew dramatically. At the end of January TVIX had $413 million in assets—fourteen days later it has $279 million more for a total of $691.0 million. Credit Suisse, which is the firm that issues the notes associated with VelocityShares’ products put new TVIX share creations on hold February 22, 2012 citing: “internal limits on the size of the ETNs.”
Normally ETN issuers love assets because the investor fees (1.65% annualized in TVIX’s case) are a prime source of income, so we know this is something Credit Suisse really didn’t want to do. The expectation is that ETN providers hedge their exposure when they issue shares, but this is not something that they provide any details or transparency into the inner workings. When I was at the IndexUniverse’s Inside ETFs Conference in January 2012 I asked representatives of several of the ETN providers if in the interests of increasing the acceptance of ETNs they were open to giving investors more insight into this hedging process. I received a very clear answer—No.
If one were prone to conspiracy theories you could imagine the issuer of a long only volatility fund like VXX or TVIX might reasonably bet that the long term value of their fund would be zero—the ravages of contango almost guarantee that will happen eventually. If that’s the case then why not dispense with all the messy hedging and just invest all the money in Treasuries? The dark side of this scenario for the issuer would be if volatility spikes up and the market is wanting to redeem shares (return shares back to the ETN provider at the net asset value in exchange for money). If they aren’t hedging their position they could be in trouble.
Credit Suisse’s action suggests that they were being careful in their risk management and that for whatever reason (e.g., costs of hedging, distortions in the volatility futures market) they wanted to put a hold on growth.
Credit Suisse still allows share redemptions so arbitragers will insure that TVIX’s value will not drop much below its indicated Net Asset Value (iNAV). However, with share creations shut down TVIX’s price can be at a premium to TVIX’s iNAV (symbol ^TVIX on Yahoo Finance). Immediately after this announcement, TVIX was trading at 17.01, almost a 6% premium to its 16.09 NAV. For people long TVIX this is obviously not a problem, but anyone that is short is feeling some pain. Fortunately ProShares UVXY offers a 2X short term long product that is very similar to TVIX, so there is a way to hedge a short position and provide arbitrage opportunities that will limit TVIX’s moves away from its iNAV.
Bill Luby from VIXandMore and Kid Dynamite both wrote excellent articles on this occurrence: Credit Suisse Suspends Creation Units, Ups and Downs of New Premium in TVIX, TVIX Not Your Daddys’ Blue Chip Stock if you would like more information / analysis.
This situation ended badly for the TVIX longs. The price of TVIX stayed relatively stable during the share creation halt period while the underlying VIX futures’ value dropped significantly. It became impossible to short TVIX because no one wanted to loan them out and Credit Suisse was not willing to create new shares that could be loaned out. Without the ability to short TVIX the Authorized Participants could not safely or profitably intervene to reduce the gap between the TVIX trading price and the fair “IV” value based on VIX futures. When Credit Suisse did resume TVIX share creations its price plummeted erasing $277 Million in market value in the blink of an eye.