BNP Paribas, the Paris-based bank, filed paperwork with U.S. regulators to market a fund that provides long exposure to forward-implied volatility of the S&P 500 Index while seeking to protect returns from the harms of contango.
The BNP Paribas Enhanced Volatility Fund (NYSEArca: BNPV) will invest in futures contracts linked to the CBOE Volatility Index, or VIX, to track its benchmark, the BNP Paribas Enhanced Volatility Strategy Index. The VIX usually spikes when the S&P 500 plunges, making it like an insurance policy that pays on turbulent days.
BNPV, which will cost an estimated 1.56 percent a year, seeks to alleviate the negative impact of contango as it rolls its exposure, giving it a similar purpose as the UBS ETRACS Daily Long-Short VIX ETN (NYSEArca: XVIX), which is designed to take advantage of inefficiencies with the VIX futures curve.
Indeed, the challenge with many volatility products is the fact that the VIX futures curve is often in contango. “Contango” means that near-term futures contracts trade at a discount to those settling in the future. That makes rolling from an expiring contract into the next one costly enough to erode returns significantly over time.
Contango is one of the main reasons why volatility-related ETNs like the market-leading iPath S&P 500 VIX Short-Term Futures ETN (NYSEArca: VXX) have lost so much money. VXX, for example, has lost almost a third of its value in the past six months, according to data compiled by IndexUniverse.
ETF industry sources generally agree that volatility-related ETFs may be good short-term tools to reap rewards as the S&P 500 plunges, but they shouldn’t be considered long-term investments.
Taking On Contango
So, tools like XVIX have been rolled out to help investors combat contango.
BNPV’s index is designed to both combat contango and also maximize rolling gains in backwardated markets—the opposite of contango, when expiring contract costs more than those for later delivery.
The fund might include cash, money-market funds and high-credit-quality fixed income such as U.S. Treasurys.
BNPV might also at times own over-the-counter derivatives, swaps or other futures contracts as proxy for VIX futures in order to conform to CBOE position limits imposed on VIX futures. That, in turn, could affect the fund’s ability to closely replicate its benchmark, the filing added.
“The trading activities of the fund take place in very volatile markets,” the company said in the filing about BNPV’s chief risks. “The VIX Index is a highly volatile index and VIX futures are amongst the most volatile futures contracts.”
“The level of the VIX Index has historically reverted to a long-term mean level and is subject to the risk associated with reversion to its mean. Accordingly, investors should not expect the fund to retain any appreciation in value over extended periods of time,” the filing added.
The fund will issue shares only available to purchase by “certain qualified financial institutions,” according to the filing.
In January, BNP Paribas licensed the S&P GSCI Dynamic Roll Index—an index created for use in investment products that could alleviate the negative impact of contango while offering lower-volatility exposure to commodities markets.
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