VIXH: Next-Gen Or Me-Too?
September 04, 2012
First Trust’s new VIXH takes its place among the confusing array of funds related to volatility and the VIX.
My colleagues recently provided an overview of the new fund. So now I want to underscore a few key points and then look at performance.
First, the First Trust CBOE S&P 500 Tail Hedge Fund (NYSEArca: VIXH) is emphatically not a short-term, high-octane volatility product like the iPath S&P 500 VIX Short-Term Futures ETN (NYSEArca: VXX).
Instead, VIXH aims to deliver one-stop shopping for a basket of U.S. stocks that also includes some protection against major downside risk.
In other words, the fund is designed to replace medium- to long-term U.S. equity positions with an equity-plus-derivative overlay.
Specifically, VIXH holds a basket of S&P 500 stocks, but it adds something extra. To protect against major downturns, the fund also buys options on the VIX index.
The idea is that the VIX—sometimes referred to as the fear index—goes up when disaster strikes. The value of the options will increase if the VIX goes up, providing a hedge to offset the loss from the stocks in the portfolio.
How Do The Options Work?
First, the fund will at times take no options position when the VIX—or, more accurately, front-month VIX futures—are very high or very low. Still, the fund’s index has had VIX options exposure over most of the past five years and all of the past three years, according to the CBOE, which runs the fund’s index.
Second, the options position, when active, varies with the level of front-month VIX futures. The fund buys one-month, cash-settled, out-of-the-money call options with a delta or sensitivity to the underlying of 0.3.
The key takeaway from the options overlay is this: The fund pays for this exposure most of the time in the hopes that it will pay off big when it’s needed most. The downside is that buying calls costs money, just like a premium on an insurance policy, and these premiums are a drag on returns.
Does It Work?
VIXH launched last Wednesday, so we’ll have to rely on a comparison of its index (VXTH) to the S&P 500 index (SPXT). Both are total return indexes. Indexes ignore fees, which gives an edge to VIXH for our analysis.
You’d expect that VIXH’s index would do well over the last five years that include the fall 2008 meltdown and S&P’s nadir in March 2009. Indeed VIXH’s returns (in blue) look good here, relative to the S&P (in gray), at 21.1 percent vs. 4.9 percent, respectively.
But what about over the past three years, where the S&P has gained 49.3 percent? I’d expect a structure that buys insurance against downside in an up market to suffer. And, indeed, VIXH’s index lags, with a return of 43.7 percent. However, it drags less than I’d expected.