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An Uber Driver’s Investment Tip Confirmed Paul Britton’s Doubts on XIVBy
Feb. 5’s haywire market cleared out ‘volatility tourists’
‘That’s very good news’ for professionals, Britton says
Paul Britton, founder of the $5.9 billion Capstone Investment Advisors, was on his way to his Manhattan office one day last fall when he received unexpected investment advice from his Uber driver.
It went like this: “‘There’s this unbelievable company, these guys just crushed it -- not sure whether it’s in biotech or a technology business, but they’re up 80 percent this year. It’s this company called XIV,’” Britton, 44, remembered the driver saying. Britton said he responded, “I’m like, ‘I’m sorry to have to tell you this, mate. That’s not a company.’”
By now, most folks following the market turmoil of last week realize XIV isn’t a stock. It’s the ticker for an exchange-traded note issued by Credit Suisse Group AG which used Cboe Volatility Index futures to bet that the stock market would remain calm. The note lost most of its value on Feb. 6, after the market roller-coastered after years of relative serenity. Now it’s shutting down, leaving investors such as Britton’s Uber driver with nothing.
Britton, whose firm trades the volatility of stocks, bonds and currencies, said he welcomes the shakeout. Complicated products like the VelocityShares Daily Inverse VIX Short-Term ETN -- designed for mom and pop investors, and some mutual funds, with the desire to cash in on years of stock-market tranquility -- had fallen into the wrong hands, he said. Volatility day traders were proliferating like pox, and so many of them were yakking to each other on Reddit that they had their own forum.
“It was a way for people to feel like they could make easy money, and with everything, if you feel as though it’s easy money, there’s substantial risk,” Britton said. “It was indicative to me that people didn’t understand the risks. They didn’t even understand what the thing was.”
Getting advice from people who didn’t possess a full understanding of where they were putting their money famously saved Joseph Kennedy, father of President John F. Kennedy, from losing a fortune in the crash of 1929. He said he sold his holdings after receiving a stock tip from the man who shined his shoes. He realized that once everyone becomes an expert, it’s time for experts to rethink.
Britton’s firm bet against the XIV toward the market close on Feb. 5, and profited as the index plunged from $99 a share to $7.35 the next day, according to a person with knowledge of the matter. The flagship Capstone Vol fund gained 7.5 percent last year, and 9 percent in 2016.
Managers’ daily rebalancing is one dynamic most retail investors know little about, Britton said.
In order to maintain a consistent degree of investment in VIX futures, the manager, in this case Credit Suisse, buys certain contracts as they rise in value and sells them as they fall. On Feb. 5, volatility-related products were forced to buy VIX futures as they rebalanced ahead of their daily deadline at 4:15 p.m. That effectively pushed up the price of the contracts. The XIV -- which soared 188 percent in 2017 and 81 percent the year before -- fell 92 percent Tuesday, triggering its closing.
Beyond the collapse of the largest volatility exchange-traded product, overall assets in the strategy have significantly shrunk in size in the wake of the sell-off. Short-volatility ETPs now manage $936 million, down from a record $3.7 billion in January, according to data compiled by Bloomberg.
To Britton, that means a source of the downward pressure on volatility that fund managers have seen in recent years has now largely been eliminated.
“This has washed out a lot of the volatility tourists in the space,” he said. “Every day these ETFs or ETNS would sell the VIX or sell volatility, which compounded the extreme low levels of volatility that we saw in 2017. Without them there, I think that that changes the dynamic of market behavior in the volatility complex. For volatility strategies, managers and players, that’s very good news.”
— With assistance by Luke Kawa, and Rachel Evans