An exchange-traded fund that appreciates as calm is restored to financial markets has never been more popular.
About $196 million was added last week to the VelocityShares Daily Inverse VIX (XIV) Short-Term ETN, which rises in value as swings decline, the most since its debut in November 2010, according to data compiled by Bloomberg. The ETN, known by its ticker XIV, may be starting to pay off after the U.S. volatility benchmark fell the most in six weeks yesterday amid a rally in stocks on higher corporate earnings.
The cash flowing into the inverse VIX note suggests some investors are confident that the strength of the U.S. economy will overshadow concerns about emerging-market currencies and the pace of China’s growth, said Randy Frederick, managing director of active trading and derivatives at Charles Schwab Corp. Data yesterday showed U.S. factory orders fell less than estimated in December.
“It’s a bet that markets will calm down and that will cause volatility to drift lower,” Frederick said in a Feb. 3 phone interview. His firm has about $2.2 trillion of client assets. “The challenge is knowing how long it might take before that happens. This whole correction could be over tomorrow. Or it might not be over until April.”
The inverse VIX note rose 1.4 percent yesterday following a 14 percent drop in the previous two days. The ETN’s assets have climbed 45 percent in the past seven days to $577 million, according to data compiled by Bloomberg.
About $2.9 trillion has been erased from the value of equities worldwide this year, following the biggest rally in four years in 2013, as China’s growth slows, the Federal Reserve cuts stimulus and anti-government protests spread in emerging markets from Thailand to Ukraine. The Chicago Board Options Exchange Volatility Index (VIX) rose 0.9 percent to 19.29 at 9:42 a.m. in New York and is up 41 percent this year. Europe’s VStoxx Index slipped 2.8 percent to 22.37.
The S&P 500 lost 5 percent since its Jan. 15 record amid signs of a contraction in China’s manufacturing and as the Argentinian government’s decision to allow the peso to devalue triggered a rout in emerging-market currencies. The Fed last week decided to press on with reductions in its monthly bond-buying program.
For David Herro, manager of the $28 billion Oakmark International Fund, the backdrop for investors remains good. The worldwide economy will grow 3.7 percent this year, up from an October estimate of 3.6 percent, the International Monetary Fund said in revisions to its World Economic Outlook released Jan. 21, citing accelerating expansions in the U.S. and U.K.
“With global growth accelerating and reasonable valuations, this looks more like markets taking a breather from the large increases in stock prices of 2013,” Herro, Morningstar Inc.’s international stock fund manager of the decade, wrote in an email.
Investors have also withdrawn money from a VIX fund that rises with higher volatility. About $388 million was pulled from the iPath S&P 500 VIX Short-Term Futures ETN (VXX) last week, the most since March, data compiled by Bloomberg show.
Volume in the inverse VIX note has soared even as the value of the security dropped. About 46 million notes changed hands on Feb. 3, the second-highest daily total since it began trading.
“People are very scared, and they want the protection basically after they need it,” Stephen Solaka, who helps oversee about $125 million as managing partner of Belmont Capital Group in Los Angeles, said in a Feb. 4 phone interview. “Those with a contrarian mindset can take advantage of that fear, and that’s what they’re doing with the inverse.”
Similar bets that volatility will subside have paid off in the past year. On April 15, trading in the inverse VIX note doubled as stocks tumbled on concern about China’s economy. While the ETN slid 12 percent that day, it recovered the drop about three months later and rose an additional 35 percent through the end of the year.
Volume also surged on June 20 amid speculation the Fed would phase out monetary stimulus. Investors who purchased the inverse-volatility fund at that day’s closing price of $18.48 made 86 percent on their investment by the end of the year.
Volatility may increase in the next couple months as investors weigh economic data such as the monthly U.S. jobs report this week, according to Terry Sandven, chief equity strategist at U.S. Bank Wealth Management. Employers probably added 184,000 positions last month, the median economist estimate from a Bloomberg survey, compared with 74,000 jobs in December, which was less than the most pessimistic projection.
“There is still some more downside,” Sandven said in a phone interview from Minneapolis. He helps oversee $115 billion. “We’ll need another round of economic readings between now and March for investors to gain back some confidence.”
Options traders have increased purchases of contracts that bet on declines in volatility. The number of VIX puts has increased 9 percent to 2.8 million since Jan. 21, while open interest in calls fell 11 percent to 7.4 million, according to data compiled by Bloomberg.
“The odds of probability are that spikes in volatility rarely last very long,” Frederick said. “While volatility spikes up very sharply, it does tend to come down a little slower than it goes up, but it generally does come down.”
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