ETF Wrap: the Groundhog Day of fiscal stimulus talks and the bet on volatility

And if you thought monitoring stimulus talks was like cats watching Wimbledon, scroll down to the bottom of this newsletter to see another installment of the back-and-forth for bank ETFs. This week, all five of the biggest gainers were bank funds. Last week, three of the five biggest losers were bank funds. The week before that, three of the five biggest gainers were bank funds.

Keep watching this space for more — and thanks for reading.

Put some ‘junk’ in your trunk — er, your portfolio

As bond yields
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around the world remain depressed — even below 0% — many investors are seeking other alternatives. How does a 6.3% yield sound?

That’s the 12-month dividend yield of the FlexShares High Yield Value-Scored Bond Index Fund
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“High-yield” is a type of debt that’s considered a riskier bet than “investment-grade” bonds. It’s often referred to as “junk bonds.”

If that sounds distasteful, it might be worth a second look. “This is not your father’s high-yield market, made up of stressed or failed credits,” said Mark Carlson, who serves as senior investment strategist for FlexShares.

Even non-“junky” corporations tap the high-yield market to raise capital, Carlson pointed out. Issuers in HYGV’s portfolio range from Ford Motor Co.
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to Staples. In fact, many of the companies that issue high-yield bonds are rated more highly along the spectrum of below-investment grade credit ratings than investment-grade companies are in their own section of the market, he said.

HYGV’s special sauce is a value factor lens applied to the universe of high-yield debt. Just like value-oriented stock pickers look for securities whose share prices don’t reflect their potential, FlexShares managers try to identify bonds that are undervalued, Carlson told MarketWatch.

“We continue to like the high-yield space because there has been support from the Fed,” he said. And while issuer defaults are likely to remain somewhat elevated, given the coronavirus crisis, Carlson sees them at “a reasonable level given the amount of disruption.”

The fund charges a management fee of 38 basis points, less than the two behemoths of the high-yield bond ETF space, the iShares iBoxx USD High Yield fund
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and the SPDR Bloomberg Barclays High Yield Bond ETF,
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which charge 49 and 40, respectively.

Is there an ETF for that?

You’ve heard it before and you’ll hear it again over the next few weeks: market volatility is likely to pick up.

MarketWatch has covered the various ways to protect a portfolio against volatility. But what if you’re intrigued by the idea of trying to make a profit from the turbulence?

“If you’re trying to target volatility itself, the only investable way to do it is by using puts and calls yourself, or by buying futures on the VIX, which is the only game in town,” said Dave Nadig, chief investment officer and director of research at ETF Flows..

A quick refresher: the “VIX” is the ticker and the nickname for the Cboe Options Exchange’s Cboe Volatility Index VIX, the most well-known and widely used measure of the stock market’s expectation of implied volatility based on S&P 500 index
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options. Options are financial instruments that allow investors to buy or sell particular assets at particular prices in the future.

Most, but not all, exchange-traded ways of buying futures tied to the VIX, are exchange-traded notes, which can be a bit challenging for individual investors to manage (see here and here). In fact, one of the biggest exchange-traded blowups of the past several years involved a VIX-related ETN.

But more to the point, Nadig says, this is a corner of the market that’s both opaque and idiosyncratic.

“The challenge is that because a VIX ETP is what I call a fifth-order derivative, something that’s derived from something that’s derived from something that’s derived from something, it is subject to moves that are not intuitive,” he said in an interview.  

In very broad terms, going “long” volatility is making a bet that it will increase. Going “short” is what you would do if you think volatility will cool down.

Here’s how Nadig describes the backdrop: “Options traders can get nervous and trigger a lot of volatility in the market. But it doesn’t hold true the same way every time. In fact, [volatility] traders can create a self-fulfilling prophecy. If they buy enough volatility futures that can drive volatility up. There’s a real tail wagging the dog situation here.”

These products really demand that investors understand what they’re buying. They span particular timeframes — measures of volatility over the next 30 days, for example. And while they may have some relationship to volatility as expressed by the VIX, they may not track it directly, as in the example of the ProShares VIX Short-term Futures ETF
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“This is not the place most people should be treading,” Nadig said. “Don’t assume you have an edge in this game. This is just trading.”

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