By Markets Media

Pros And Cons Of ETPs

Exchange-traded funds and notes are the asset class du jour since 2010. Their deep liquidity and transparency allow for both retail and institutional investors to gain access to different baskets of products that would otherwise be costly and inconvenient perhaps from a portfolio margining standpoint.

But one of the problems that is inherent with exchange-traded products is the lack of clarity that exists within them. This is primarily true with notes, which have counterparty risk and no real assets backing them. Perhaps one of the most famous ETNs is the VXX, the most heavily traded ETN that mimics performance of the CBOE Volatility Index(VIX).

The obvious problem with VXX is that you can’t “own” the VIX. So what is it that you actually own? TD Ameritrade’s Alex Perel, who runs the broker’s exchange traded products desk, explains:

“With respect to VIX and ‘owning vol’ I think the key take-away is that you can’t get something for nothing. VIX is not the only ‘un-ownable’ quantity – if you want to be long and stay long, you’re going to essentially pay someone to take the other side, through roll yield etc.,” Perel told Markets Media.

“Volatility products in and of themselves aren’t any riskier than others but investors need to understand what they’re buying… clearly people didn’t,” continued Perel. “The issue with TVIX/VXX in particular is that there is NO natural supply of volatility per se, the way you’d have in, say, an energy commodity. You don’t have “VIX producers” selling futures to hedge their future production.”

The problem exists both domestically and abroad. The problem, however, is that there is investor demand for ETNs despite their shortcomings.

“ETNs are a debt instrument, end of discussion. Whomever issues it is your counterparty. That’s it, that’s all. The Canadian ETNs that exist are issued by Deutsche and BarCap, and are cross-listings of their US offerings,” said Perel.

Related articles

  1. European Commodity ETFs Have Record Inflows

    ETFs and ETPs industry will turn 30 years old on March 9.

  2. Active Investing Poised for Rebound?

    Investing in ETFs in 2020 will require a balanced and steady approach.

  3. SIX now has 19 tradable ETPs with more than half having a crypto currency as underlying.

  4. This instrument is first backed by US cannabis companies.

  5. ETFs to Increasingly Replace Futures

    US equities lead the way.