The Elusive VIX Hedge
By Roger Nusbaum AdvisorShares ETF Strategist
Last week I got an email solicitation about a mutual fund I had never heard of that seemed to have an interesting idea for a strategy. All advisors get inundated with these emails, I think what caught my eye was the word volatility in the subject. For compliance reasons, I can’t mention specific names but I think the details will be very clear.
The basic idea is to manage volatility around a core equity portfolio. The fund owns one of the large S&P 500 ETFs for equity exposure, uses one of the popular VIX ETPs for volatility management and may have cash as well. Google Finance listed the holdings as 93% equity, 4% VIX ETP and although not listed the rest must have been cash. Also, where this is a traditional mutual fund I am sure the holdings info was stale but Google didn’t have a date.
The fund’s literature makes it clear that the weightings change frequently. The investment objective is somewhat opaque but a little deeper in the prospectus the manager offers that fund tries to “capture favorable volatility movements in the equity markets while maintaining equity exposure to preserve positive performance during extended periods of rising markets.”
It appears as though capital appreciation may not be an objective as a “control f” search returned no results. I am guessing that the managers do care about capital appreciation but for 2016 but they didn’t get too much of it. The fund was up 0.34% in 2016 (its inception was mid-2015) versus about 11% for the S&P 500 index. Technically the SPX is not the benchmark but there is relevant context as the fund uses an S&P 500 tracker for equity exposure and as noted above can go very heavy into that tracker. The upcapture for its first full calendar was obviously not good and the fund charges 2%. I take that expense ratio to mean that the fund does a lot of trading.
There is probably not much of an audience for a mutual fund that charges 2% for a 90% weight in an ETF that charges less than 10 basis points unless returns go on to do something epic but that does not mean this is not interesting or that we can’t learn from it.
The concept of using VIX, paired with an equity ETF to get a superior risk adjusted result (the term risk adjusted is not in the prospectus either) is worth learning about, maybe you implement maybe you don’t. If you look at the ETPs that track VIX is that they all go down a lot save for the occasional spike. This in part has to do with how the futures roll but also what the futures are actually tracking which is not the headline VIX index that everyone looks at on a regular basis. A three-month futures contract is trying to predict where the VIX index will be in three months. So very little of the daily moves are captured by the ETPs, so it would be reasonable to question their efficiency and in that light, may not be capable of doing much good for the mutual fund.
I wrote about the inefficiency of the VIX products for theStreet.com back in 2009 so it is interesting to see it play out with this fund. Some of the VIX products have huge assets so there must be people speculating with them successfully but it is hard to see how total reliance as a long-term hedge can work, at least with the products as we now know them.
There are a lot of mutual funds and ETFs that implement some very interesting strategies, not all of them can work but plenty do and this type of study is worthwhile. A VIX below 12 would seem to be as low as it could go and as Steven Sosnick said in this week’s Barron’s “Trump’s personality is incompatible with a 12 VIX” so it would be useful if there were a fund that could effectively harness the VIX as a downside hedge.