Tag Archives: inverse ETFs

sec-chair-white-marketsmuse

SEC Chair White: “I Have A Dream..”

SEC Mary Joe White has a dream, and even if she aspires to leverage the inspirational outlook of  Dr. Martin Luther King, securities industry members are debating whether her dream could prove to be a reality any sooner than the civil rights agenda expressed by Dr. King so many years ago.  In a series of comments during the past several weeks from Chairperson White regarding the SEC’s agenda for the remainder of her tenure as President Obama’s designated SEC Chairperson, Ms. White, who is operating with only 3 of 5 Commissioners until two open vacancies are filled before the Second of Never,  she is vowing one of the top three items on her list includes “better understanding exchange-traded funds aka ETFs before the SEC approves prospectuses.” That makes sense.

One only wonders why that elementary concept had never occurred to any one previously—despite repeated calls from among others, former SEC Commissioner Steve Wallman (1994-1997) who has long questioned the approval process for many of the complex exchange-traded products the SEC has rubber-stamped, including inverse and commodities-related products that even professionals often do not understand.  Since his departure from the SEC, Wallman has proven adept at doing the right things while serving at the helm as Founder/Chairman/CEO of the investment firm Foliofn.com.

Other matters of importance according to White include “the desire on part of SEC to introduce “fiduciary definitions for registered advisers and brokers..” which in plain speaks means : White’s agenda is to figure out how to completely change the culture of the securities brokerage industry by forcing people to be ethical and moral. MarketsMuse sources have indicated White is proposing to have those folks swear an oath that says:

“My first obligation is to protect my clients’ interest above all else and to make sure I never even think of trying to sell them something that might be inappropriate for their goals or possibly even toxic—despite the fact my office manager says I have to sell house product only or I’m out of a job. After I meet that first obligation, my second obligation is to then make enough money to pay for my kids college and have enough left over for that condo in Florida.”

Insiders familiar with White’s agenda have told MarketsMuse that she has acknowledged her seemingly altruistic mission is not without challenge or headwinds given that the “securities industry at large is much like the NRA when it comes to influential prowess.”

Directly and indirectly, Wall Street firms and its executives contribute hundreds of millions of dollars every year to lobby SEC Officials and members of Congress(which the SEC reports to) on behalf of their interests—which presumably includes two big drivers that have driven the investment industry since the days of Joe Kennedy Sr.: (i) selling investment vehicles that look great on paper and in marketing collateral [even if they might or might not prove to be toxic at some point and might or might not be appropriate for a specific individual given that people’s moods change a lot] (ii) how to pay the mortgage on the brokers’ first house, the $200k for each of their kids college tuition bills, the country club memberships that provides venues in which to sell those investment products,  sharpen up the golf game, and of course, pay for the second and third homes, etc etc.

Another item on White’s laundry list is to expand the  exam program for registered brokers and advisers. Currently, 10% of the nearly 12,000 advisers sit and take ‘refresher tests’ that are abridged versions of the Series 7—an exam that has approximately 40% brokers FAIL the first time and 30% fail the second time. Some could argue the test is maybe too difficult, given the national average score is 67 vs. a passing grade of 72. Or, one could argue the barrier to entry to become a registered broker or adviser is simply being a good test taker. Idiots and Muppets can get licensed, as long as they take 8 practice exams the night before the actual exam and memorize the correct answers. So, Chairperson White wants more folks taking more tests; a good thing for the SEC because this is big a revenue-generator for the Agency—which has repeatedly claimed it does not have enough money to even pay for air conditioning in its Washington DC office. Staff members have said this alone is vexing, given that SEC examiners and enforcement agents have become accustomed to keeping windows wide open five months of the year and continuously grapple with files on their desks blowing out of their windows and many of those files pertain to complaints filed by investors and updated paper notes sent by from enforcement agents in the field via courier pigeons.

Courtesy of  an admittedly more illustrious news media outlet than MarketsMuse might be, the following is ‘official coverage from InvestmentNews.com:

(InvestmentNews) Despite missing two of its five members, Securities and Exchange Commission Chairwoman Mary Jo White said Friday the agency will forge ahead on rules to raise investment-advice standards and enhance oversight of advisers.

“At the moment, as you know, we are a commission of just three members, but — as has occurred in the past — we can carry forward all of the business of the commission,” Ms. White said at the Practising Law Institute conference in Washington. “And, while we look forward to welcoming new colleagues, Commissioners Stein, [Michael] Piwowar and I are fully engaged in advancing the commission’s work.”

The Obama administration has nominated Republican Hester Peirce and Democrat Lisa Fairfax to replace two members who have departed the SEC, Republican Daniel Gallagher and Democrat Luis Aguilar, but the Senate has not yet begun the confirmation process. Continue reading

leveraged ETFs

The Big Short: Leveraged ETFs, By David Miller

The Big Short is coming to a theater near you soon, but the hedge fund industry’s cool kid of the year David Miller has traded ahead of his peers by exploiting and being short of the popular ETF industry product: leveraged ETFs  and “inverse ETFs”; products that are typically powered by futures contracts so as to magnify returns of a move in a particular index.

Exchange-traded funds that employ derivatives or futures contracts have [rightfully so] been the subject of increasing scrutiny of late, a topic discussed more than once by MarketsMuse. As tweeted earlier today by our curators, the SEC which is notorious for chasing horses after they’ve left the barn, is now taking an even deeper dive towards determining the efficacy and credibility of these testosterone-charged ETFs—albeit putting the Genie back in the bottle will prove non-trivial for regulators. That said, one macro strategy-centric hedge fund manager is exercising his fund’s trade strategy options by leveraging the short-comings of these products by systematically shorting a laundry list of the so-called 2x and 3x return products, and he’s been smiling all the way to the top of the list of 2015’s best performing HF managers.

As reported by Reuters’ David Randall, the $155mil AUM Catalyst Macro Strategy fund, run by 35-year old David Miller is the cool kid of the year for using exchange-traded options to short leveraged exchange traded funds that offer two or three times the daily positive or negative return of an index and which have become increasingly popular among hedge funds and other traders as the broad U.S. market has flatlined. Leveraged ETFs have seen inflows of $9.5 billion this year, according to Lipper data.

Here’s the opening excerpt from Reuters’ reporting..

david miller catalyst macro…. Miller’s $155.6 million Catalyst Macro Strategy fund, has posted returns of nearly 47 percent over the last year by focusing on the flaws of levered exchange-traded funds. That performance makes Miller’s fund the best performer among all actively-managed equity funds tracked by Morningstar this year, and nearly 20 percentage points greater than the next-best performing fund.

The average hedge fund, by comparison, gained 1.1 percent over the same time, the lowest return since the average loss of 5.4 percent in 2011, according to BarclayHedge.

At the heart of Miller’s strategy is a bet against what he calls “structurally flawed” ETFs. He has a list of approximately 100 such ETFs, nearly all of them leveraged, that he uses as the basis for his trades.

Miller’s base case is that most leveraged ETFs are poorly designed because the nature of compounding wipes out their gains over time.

An investor who puts $100 into a two-times leveraged fund realizes a gain of 20 percent if the index it tracks goes up 10 percent in one day. Yet if the same index goes down 9.1 percent the next day to fall back to its starting point, the same investor who had $120 will realize a loss of 18.2 percent – or $21.84 – and be left with just $98.16.

Miller uses options to hedge his holdings, focusing on making bets that an ETF will have choppy trading rather than sprinting off in any direction, a strategy that he says limits his losses.

For example, he has a net short position on both an ETF that offers a triple positive return of an index of Russian stocks and one that offers a triple negative return of the same index based on the idea that Russian stocks tend to be volatile.

Indeed, both funds are down this year significantly, while their underlying index, the Market Vectors Russia ETF index (NYSE:RSX), is up 22 percent. The bullish fund down 27.6 percent while the bearish fund is down 66.9 percent.

To be sure, the strategy is not foolproof and carries risks of its own, including high trading costs incurred from frequent options trading and the risk that a leveraged ETF goes on a prolonged run beyond Miller’s strike price, leaving him on the hook for theoretically unlimited losses.

At the same time, the U.S. Securities Exchange Commission proposed a rule on Friday that would force ETFs to limit their derivatives exposure, potentially forcing most leveraged ETFs to shut down [L1N1401IW]. In that case, Miller said he would be forced to pivot his options strategy to focusing on “inconsistencies” in the futures market for commodities.

So far, Miller has been able to hedge away most of his losses. He has a net short position on the ProShares Ultra VIX Short-Term Futures ETF (NYSE:UVXY), a fund that returns two times the daily performance of the S&P VIX Short-Term Futures index.

The fund shot up more than 11 percent on December 9 of this year. Yet Miller is willing to look past such daily losses and focus on the long-term tendency of leveraged ETFs to “decay,” he said. The same fund he has a net short position on, for instance, has a 78 percent decline for the year to date.

Fund experts say that Miller’s strategy of using options to short leveraged ETFs is unique, but does not have a long enough track record to be judged as anything more than a fluke.

“This is quite rare to find any fund that is using this as part of their strategy,” said Todd Rosenbluth, director of mutual fund research at S&P Capital IQ.

At the same time, Miller’s short track record is its own risk, he said. His strategy “has worked out excellently this year for this fund, but it’s still only one year of performance,” he added.

Miller, meanwhile, says that he has such a long list of what he calls poorly thought-out ETFs that he feels no need to hope that the fund industry keeps introducing more of them.

“There are so many terribly designed products out there already,” he says.

(Reporting by David Randall, with additional reporting by Saquib Ahmned; editing by Linda Stern)
Read more at Reutershttp://www.reuters.com/article/us-catalyst-fund-etf-idUSKBN0TW0TX20151213#mdFJfVOuVEKxhbSp.99

Fed Does Walk Back On Leveraged ETFs; Now Endorsed in US Govt Study

MarketsMuse editor note: For those not familiar with leveraged ETFs, before reading this special column, you’ll want to get up to speed with Investopedia’s defintion, otherwise, ETF industry experts and observers have new ammunition in which to debate the pros and cons of leveraged ETF products. If you find that your debate with peers becomes too spirited, you might change the channel and duel about the merits of shale oil fracking..

Leveraged and inverse ETFs, which some industry experts have labeled “Weapons of Financial Destruction” aka “WFDs” have come under heavy criticism as potentially exacerbating volatility in financial markets, are not the danger that critics have made them out to be, concludes a preliminary study from U.S. Federal Reserve researchers.

“..Leveraged and inverse exchange-traded funds (ETFs) have been heavily criticized for exacerbating volatility in financial markets because it is thought that they mechanically rebalance their portfolios in the same direction as contemporaneous returns. We argue that these criticisms are likely exaggerated because they ignore the effects of capital flows on ETF rebalancing demand. Empirically, we find that capital flows substantially reduce the need for ETFs to rebalance when returns are large in magnitude and, therefore, mitigate the potential for these products to amplify volatility. We also show theoretically that flows can completely eliminate ETF rebalancing in the limit.”  US Federal Reserve study, November 2014
Continue reading

Macro Muse: Expert Says: Short USTs, Yields Poised to Rise

Courtesy of one of our reader’s sighting this a.m.’s comments from Rareview Macro LLC’s “Sight Beyond Sight”, we’re compelled to cite the original source:

Neil Azous, Rareview Macro LLC
Neil Azous, Rareview Macro LLC

“…For the first time in months the setup is compelling enough for us to short US Fixed Income.

Earlier this morning the model portfolio sold short enough 30-year bond futures (symbol: USM4) at 135-28 to risk $50,000 USD per basis point. The reference point or last yield on the 30-year cash bond is ~3.40%. The first target in cash yield terms is 3.48% and the second is 3.52%. A stop at 3.36% (closing basis) has been placed. This is a short-term tactical trade with a risk-reward profile of three to one (3:1)…”

For those who embrace the above outlook, our insightful reader who pointed out the above sighting caveats: You can increase your chances by using a non-leveraged short ETF like TBF or simply shorting the long ETF. Beware: shorting bonds ETFs will result in you having the pay the dividends, which can be substantial.

Below includes a snapshot of (3) inverse-bond ETFs that could be considered by those seeking to hedge against or exploit a pending spike in UST yields. *

Note: MarketsMuse DOES NOT OFFER OR RECOMMEND TRADE IDEAS, NOR DO WE ENDORSE ANY SPECIFIC ETF PRODUCT Continue reading

Finra Fines Wells Fargo, Three Others Over ETF Sales

Citigroup Inc. (C), Morgan Stanley, UBS AG (UBSN) and Wells Fargo & Co. (WFC) agreed to pay a combined $9.1 million to settle regulatory claims they failed to adequately supervise the sale of leveraged and inverse exchange-traded funds in 2008 and 2009.

The firms also didn’t have a reasonable basis for recommending the securities to their clients, the Financial Industry Regulatory Authority said today in a statement. They will pay fines of about $7.3 million and reimburse $1.8 million to customers.

“The added complexity of leveraged and inverse exchange- traded products makes it essential that brokerage firms have an adequate understanding of the products and sufficiently train their sales force before the products are offered to retail customers,” Brad Bennett, Finra’s chief of enforcement, said in the statement.

Finra warned brokers in June 2009 that leveraged and inverse ETFs were difficult to understand and not a good fit for long-term investors. ETFs typically track indexes and trade throughout the day on an exchange like stocks. Leveraged versions use swaps or derivatives to amplify daily index returns, while the inverse funds are designed to move in the opposite direction of their benchmark.

Because gains or losses in the funds are compounded daily, returns of more than one day can differ from expected returns gauged by the underlying index.

Firm Assessments

Wells Fargo, based in San Francisco, was assessed the highest fine at $2.1 million and must pay $641,489 in restitution. Citigroup, based in New York, received a $2 million fine and must pay $146,431 in restitution; New York-based Morgan Stanley will pay a $1.75 million fine and $604,584 in restitution; and Zurich-based UBS will pay a $1.5 million fine and $431,488 in restitution.

In settling the claims, the firms neither admitted nor denied the charges, said Washington-based Finra, the brokerage industry’s self-funded regulator.

For more on this “believe-it-or-not, this sh*t still happens story”, please go to Bloomberg LP; the first reader comment is a doozy!