In the last few weeks VelocityShares‘ TVIX ETN has been on a tear. Its volume has surged from an average of 6.67 million shares a day in January to 22 million shares a day in February. The assets under management (AUM) have also grown dramatically. At the end of January TVIX had $413 million in assets—fourteen days later it has $279 million more for a total of $691.0 million. Credit Suisse, which is the firm that issues the notes associated with VelocityShares’ products put new TVIX share creations on hold yesterday citing: “internal limits on the size of the ETNs.”
Normally ETN issuers love assets because the investor fees (1.65% annualized in TVIX’s case) are a prime source of income, so we know this is something Credit Suisse really didn’t want to do.The expectation is that ETN providers hedge their exposure when they issue shares, but this is not something that they provide any details or transparency into the inner workings. When I was at the IndexUniverse’s Inside ETFs Conference in January I asked representatives of several of the ETN providers if in the interests of increasing the acceptance of ETNs they were open to giving investors more insight into this hedging process. I received a very clear answer—No.
If one were prone to conspiracy theories you could imagine the issuer of a long only volatility fund like VXX or TVIX might reasonably bet that the long term value of their fund would be zero—the ravages of contango almost guarantee that will happen eventually.If that’s the case then why not dispense with all the messy hedging and just invest all the money in Treasuries? The dark side of this scenario for the issuer would be if volatility spikes up and the market is wanting to redeem shares (return shares back to the ETN provider at the net asset value in exchange for money).If they aren’t hedging their position they could be in trouble.
Credit Suisse’s action suggests that they are being careful in their risk management, and that for what ever reason (e.g., costs of hedging, distortions in the volatility futures market) they want to put a hold on growth.
Credit Suisse still allows share redemptions so arbitragers will insure that TVIX’s value will not drop much below its indicated Net Asset Value (iNAV). However with share creations shut down, TVIX’s price can be at a premium to TVIX’s iNAV (symbol ^TVIX-IV on Yahoo Finance). Currently TVIX is trading at 17.01, almost a 6% premium to its 16.09 NAV. For people long TVIX this is obviously not a problem, but anyone that is short is feeling some pain. Fortunately ProShares UVXY offers a 2X short term long product that is very similar to TVIX, so there is a way to hedge a short position and provide arbitrage oppportunities that will limit TVIX’s moves away from its iNAV.
Bill Luby fromVIXandMore and Kid Dynamite have both written excellent articles on this occurrence: Credit Suisse Suspends Creation Units, Ups and Downs of New Premium in TVIX, TVIX Not Your Daddys’ Blue Chip Stock if you would like more information / analysis.
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