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.
What happened with the inverse VIX ETPs was an isolated case during the recent market volatility as the plunge was attributed to the sudden spike in VIX futures due to heavy after-hours trading.
“Believe it or not, it was business as usual for us last week,” O’Rourke told ETF Trends. “We perform daily rebalance trades on all leveraged products, and most of these trades were larger than the averaged, but our systematic process was followed and we had no operational issues.”
Direxion Funds is known for its inverse and leveraged ETFs but it does not offer any VIX-related funds. O’Rourke explained that their inverse and leveraged ETFs operated normally, with none of their funds down more than 15% – their 3x or 300% products would lose three times the amount when the markets fall 5% on any given day.
ProShares, which is also known for its suite of leveraged and inverse products, also came back and painted a picture of normal ETF operations with tight bid-ask spreads and heightened volume on the greater volatility.
Like any other complex investment product, investors should be aware of the potential risks associated with these leveraged and inverse products. Investors may be mad if they are on the wrong side of the trade, but they should understand that that is the risk they are willing to take for the potential upside these types of products may produce.
For more information on geared products, visit our leveraged ETFs category.