Earlier this month, we discussed how ETF flows have historically responded to market downturns. That said, we did not anticipate the drawdown to return so violently, nor did we expect Volatility ETPs to be at the center of this sell off. This week, as requested by some ETF Think Tank members, we provide a more granular review of ETF flows post sell offs, and then a deep dive into what happened with Volatility ETPs.
In the last TETFindex update, we showed the flows of all US ETFs in the 3 months following any 6% monthly drop in the S&P 500. This prompted some ETF Think Tank members to ask which asset classes received those flows.
ETF FLOWS BY ASSET CLASS AFTER A DRAWDOWN
Source: Morningstar
As noted in the chart, ETF flows following a drawdown have been consistently positive across asset classes. The one exception is the market bottom in early 2009 where Equity ETFs saw about $23 Billion in outflows during the three months following an 8.4% drop in the S&P 500. We believe ETF flows will continue to respond positively to market drawdowns.
NOW ONTO VOLATILITY ETPs
As of 2-9-18, Volatility ETPs represent $4.05 billion of ETF assets down from $5.98 billion a week earlier. They represent a small but lucrative component of the ETF ecosystem. On Monday 2-5-18, two inverse volatility ETPs, for lack of better words, imploded. Toroso would like to share some of our thoughts on the headlines that have ensued and dispel some myths in the process.
#1- THIS HAS NEVER HAPPENED BEFORE!!!
FALSE
In 2011, an extremely similar ETN, iPath® Inverse S&P 500 VIX Short-Term FuturesTM ETN (IVO) was closed under extremely similar circumstances. So history has repeated, but the assets are substantially higher this time around.
#2- THIS IS A BLACK EYE FOR ETFS!!!
FALSE
The products traded orderly and did exactly what was described in the prospectus. Bloomberg has provided research contradicting the claims that this is an ETF issue.
#3- THIS WAS A COMPLETE SURPRISE, THAT NO ONE SAW COMING!!!
FALSE
The prospectus for all these products describe in bolded black and white the possibility and circumstances that could lead to the early termination of these products. Additionally, most custodians require investors to acknowledge this risk before allowing investors to trade them. In 2015 we wrote a piece on ETF.com describing the use of XIV as “picking up dollars in front of a steamroller”, so we urged consistent profit harvesting and proper position sizing.
#4- THIS HAPPENED AFTER MARKET HOURS!!!
PARTIALLY FALSE
The collapse in underlying value of these products did occur after 4 pm when ETF trading ended. That said, VIX Futures trade until 4:15, during that 15-minute window the Futures traded at extraordinary levels forcing the collapse. It is possible that a Hedge Fund facilitated the exacerbated pricing for profit. It’s our belief that in the end, it will be a hedge fund or some bank proprietary trading desk with the black eye. That said, these after-hours moves could happen with any asset (international stocks, commodities, currencies) that trade when US-listed ETFs are not trading.
LETS END WITH A TONGUE TWISTER
Despite the volatility and the volatility of volatility of volatility ETPs, we believe ETFs will continue to grow and TETFindex (Click here for more information on the ETF following this index) is the way to track that growth. And remember, volatility is normal; complacency is the anomaly.
This article was written by Toroso Asset Management, a participant in the ETF Strategist Channel.
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