The recent market sell-off that triggered a precipitous plunge in inverse or short CBOE Volatility Index-related exchange traded products has caused many to censure the complex ETP group. However, investors should not blame what happened to the leveraged and inverse exchange traded fund and note investment vehicles.
ETPs that short the CBOE Volatility Index, or VIX, saw their market value plunge on Tuesday. However, investors should keep in mind that those exposures had an impact on the VIX futures market, not the overall equity market. The VIX futures market impact was captured in post-market trading on Monday when the VIX increased 20 points – the largest absolute or percentage change ever. The VIX move was estimated to be a result of covering inverse ETP’s short future positions and adding to levered product’s long positions.
“Leveraged ETFs behaved exactly as they were designed to,” Andy O’Rourke, Chief Marketing Officer for Direxion Funds, explained in a call with ETF Trends. “They are leveraged 2X or 3X, so the fluctuations are expected to be large on days like Feb. 5th, and we go to great lengths to ensure that investors do their homework to understand how they work.”
Market observers should not confuse the tail wagging the dog. In this case, ETFs and ETNs were not a market driver. Some naysayers have painted all inverse and leveraged ETFs with a broad brush, arguing that these inverse and leveraged products were to blame for the sudden fallout.
O’Rourke said the vast majority of leveraged ETFs are, in fact, 1940 Act Funds, not ETNs or 1933 Act ETPs, adding all 1940 funds must be based on underlying assets that are investable, not synthetics like the VIX.
According to XTF data, there are 142 U.S.-listed leveraged ETFs with $32.2 billion in assets under management, 45 inverse ETFs with $4.9 billion in assets and 84 leveraged inverse ETFs with $9.3 billion in assets. Given the relatively small amount of money in these leveraged and inverse ETFs compared to the money in margin accounts and futures, it is absurd to think that they would act as market drivers.