What’s in a name? When it comes to exchange-traded funds, the answer could mean the difference between surviving a volatile market and getting wiped out.
ETFs have tripled their assets to $3.4 trillion over the last six years, capitalizing on demand for cheaper alternatives to mutual funds during one of the longest bull-runs in U.S. stocks in history. But along the way, the meaning of those three letters has blurred, lumping together simple portfolios that track the S&P 500 Index with complex combinations of securities that promise to deliver, say, three times the move in the price of oil.
And all of this has left some investors with little idea of what they own and little understanding of how these products will perform under stress.
This concern came into focus last week when XIV, a $1.9 billion exchange-traded note that bets on market calm, lost 90 percent of its value in a day. While XIV’s prospectus spelled out the risks -- that it was a debt obligation, that it could shutter at any time and that its value could and would fall toward zero -- less-sophisticated investors saw it as just another ‘‘ETF.’’
“It’s like alphabet soup, confusing as hell,” said Eric Balchunas, an ETF analyst at Bloomberg Intelligence. “XIV taught at least some investors the difference between an ETF and an ETN.”
Defining Terms
You can understand the confusion. Exchange-traded products -- a catch-all term for these securities -- mostly trade under three- or four-letter tickers and can be bought and sold at any time, just like stocks. Collectively, they’ve become a core part of many portfolios, offering access to everything from Chinese equities to real estate investment trusts to gold.
And yet, in many ways they’re market mysteries because of the different rules governing each product. Some retail investors confess that the first time they heard the acronym ‘‘ETN’’ was after they’d lost thousands of dollars on one. There are $24 billion of ETNs that trade in the U.S. under similar terms as XIV, data compiled by Bloomberg show.
Unlike ETFs, ETNs are debt instruments that are backed by their issuers -- typically a bank -- rather than a pool of assets and often focus on esoteric strategies that don’t easily fit in a fund. In XIV’s case, Credit Suisse Group AG was the issuer and, under the terms of its offering documents, the bank could accelerate and redeem the note at will.
That’s why XIV is closing. Meanwhile, it’s business as usual for a rival product. The ProShares Short VIX Short-Term Futures ETP, which goes by the ticker SVXY and deploys a similar investment strategy, is still trading despite losing 90 percent of its value over the last two weeks. Why? Because it’s not a note and therefore operates under different rules.