How does the IVOL ETF work?

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GaryA505
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How does the IVOL ETF work?

Post by GaryA505 »

Does anyone know how the IVOL ETF (The Quadratic Interest Rate Volatility and Inflation Hedge) works? Apparently they're buying TIPS with most of the assets (87%) and then using the rest of it to make some some of bets with options. I was reading about this and it seems interesting. Would any interest rate gurus or inflation experts care to take a whack at explaining it?
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whodidntante
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Re: How does the IVOL ETF work?

Post by whodidntante »

It works by offering an exotic exposure and charging unsuspecting investors a lot to get it. I kid, I kid.

Well, let's see what they say they are offering.
IVOL is a first-of-its-kind ETF which is designed to hedge the risk of an increase in fixed income volatility and/or an increase in inflation expectations. It also seeks to profit from a steepening of the yield curve, whether that occurs via rising long-term interest rates or falling short term interest rates, which are historically associated with large equity market declines.
What makes IVOL unique is that it is long interest rate volatility via its access to the OTC fixed income options market. No other active or passive ETF has provided its investors access to this market before.
OK, maybe I wasn't kidding.

It sounds like they are buying TIPS and shorting long-term Treasuries using derivatives that you need an ISDA Master Agreement to trade.
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Re: How does the IVOL ETF work?

Post by GaryA505 »

Has anyone taken a stab at simulating IVOL in Portfolio Visualizer?
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Nate79
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Re: How does the IVOL ETF work?

Post by Nate79 »

This ETF was covered in the recent podcast Let's talk ETFs, on Aug 20th.
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Re: How does the IVOL ETF work?

Post by nisiprius »

Wow!

Is that the record for an expense ratio on an ETF, or does someone know of something higher?

Image

For comparison, the average expense ratio for actively managed mutual funds is 0.74% for stock funds, 0.56% for bond funds; see ICI Factbook, fig. 6.7, p. 127.

Hmmmm.... You can't download the prospectus from the https://www.ivoletf.com/ivol-materials/ website?
The fund's investment objectives, risks, charges and expenses must be considered carefully before investing. The prospectus contains this and other important information about the company and may be obtained by calling +1-833-IVOL-ETF. Please read it carefully before investing.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
Elysium
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Re: How does the IVOL ETF work?

Post by Elysium »

85% of it is invested in another TIPS ETF, SCHP, for efficiency reasons they do not wish to replicate a TIPS portfolio by buying & selling individual TIPS securities. The fee for SCHP is waived, that leaves the 1% management fees for the 15% active managed portion of assets. What they are trying to do with the 15% really works when there is higher inflation, yield curve widens, and there is higher volatility. The opposite is true when rates drop or volatility drops. They do buy options to get exposure to non-CPI inflation, like some rents that are non-correlated to most individual investors, which I don't really understand how that works. Monthly data so far has shown it provides protection when long rates go up, and the opposite when they drop, same with rate volatility and TIPS price movements. Really those three things are what can make or break the portfolio.

It works when it works, and in the end expenses may erode long term benefits from any value added from active management . That's the only real risk I see, now if they can drop that expense ratio by half then may be it has a fighting chance of delivering what they promise. But, I don't see how it will be feasible for them to do that without gathering several billions in assets.

All of the details on the strategy is explained here in this podcast/article.
Last edited by Elysium on Sat Oct 24, 2020 7:11 pm, edited 4 times in total.
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Re: How does the IVOL ETF work?

Post by nisiprius »

Links to the usual documents seem to be here, and the prospectus seems to be here: Prospectus, August 1, 2020

The "Principal Investment Strategies" section begins with the words
The Fund is actively managed
and continues
...and seeks to achieve its investment objective primarily by investing, directly or indirectly, in a mix of U.S. Treasury Inflation-Protected Securities (“TIPS”) and long options tied to the shape of the U.S. interest rate curve.
The next few paragraphs give more details. I note:
Investments in derivative instruments, such as options, have the economic effect of creating financial leverage in the Fund’s portfolio because such investments may give rise to gains or losses that are disproportionate to the amount the Fund has invested in those instruments... The Fund is likely to be significantly more volatile than a fund holding only long positions in the same U.S. government bonds as the Fund because the options component of the Fund could result in significant gains for the Fund or in a complete loss of the premium for the Fund’s options.
A year of history means nothing, but compared to the TIPS fund, VAIPX (which I happen to hold) IVOL has indeed had somewhat higher volatility, and somewhat lower risk-adjusted return. If interest rates do rise and IVOL does in fact hedge away or profit from that rise, the investor may still be paying a price in the form of higher volatility.

Source

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Re: How does the IVOL ETF work?

Post by nisiprius »

Elysium wrote: Sat Oct 24, 2020 7:02 pm...All of the details on the strategy is explained here in this podcast/article...
Thanks.
[Nancy Davis]: ...I hope my firm Quadratic is known as the Vanguard of Convexity Solutions in a couple years.
8-)
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Re: How does the IVOL ETF work?

Post by valleyrock »

Grant's Interest Rate Observer did a podcast about this ETF with its head, Nancy Davis, on October 16.

https://www.grantspub.com/podcasts.cfm?podcastform=1

As noted above, one of the "selling points" Nancy Davis touts is access to the options market, which she says is valued at $22 Trillion, and she says this is where big time real estate investors hedge, but most people just own stocks and bonds, and it would help them to diversify with IVOL.

As she said, the TIPS component of the fund does better if interest rates fall, but really it would not seem they can fall much more, can they?

She's been making the rounds. Does this mean that, as I heard Bill Bernstein say, if it's in the news, it's too late to make money with? Or is this a unique product that can be good for generating income (about 11% year to date)?
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Re: How does the IVOL ETF work?

Post by whodidntante »

nisiprius wrote: Sat Oct 24, 2020 6:29 pm Wow!

Is that the record for an expense ratio on an ETF, or does someone know of something higher?

Image

For comparison, the average expense ratio for actively managed mutual funds is 0.74% for stock funds, 0.56% for bond funds; see ICI Factbook, fig. 6.7, p. 127.

Hmmmm.... You can't download the prospectus from the https://www.ivoletf.com/ivol-materials/ website?
The fund's investment objectives, risks, charges and expenses must be considered carefully before investing. The prospectus contains this and other important information about the company and may be obtained by calling +1-833-IVOL-ETF. Please read it carefully before investing.
It's not even close to a record.
https://etfdb.com/compare/highest-expen ... %20rows%20
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Re: How does the IVOL ETF work?

Post by NoRegret »

whodidntante wrote: Thu Oct 29, 2020 9:54 pm
nisiprius wrote: Sat Oct 24, 2020 6:29 pm Wow!

Is that the record for an expense ratio on an ETF, or does someone know of something higher?

Image

For comparison, the average expense ratio for actively managed mutual funds is 0.74% for stock funds, 0.56% for bond funds; see ICI Factbook, fig. 6.7, p. 127.

Hmmmm.... You can't download the prospectus from the https://www.ivoletf.com/ivol-materials/ website?
The fund's investment objectives, risks, charges and expenses must be considered carefully before investing. The prospectus contains this and other important information about the company and may be obtained by calling +1-833-IVOL-ETF. Please read it carefully before investing.
It's not even close to a record.
https://etfdb.com/compare/highest-expen ... %20rows%20
IVOL is on the expensive side for sure but you need an ISDA to access OTC rates derivatives. Its AUM has doubled in the last couple of months from under $300M so hopefully they will reduce the ER at some point, especially if growth continues.
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Re: How does the IVOL ETF work?

Post by JackoC »

valleyrock wrote: Thu Oct 29, 2020 9:12 pm As noted above, one of the "selling points" Nancy Davis touts is access to the options market, which she says is valued at $22 Trillion, and she says this is where big time real estate investors hedge, but most people just own stocks and bonds, and it would help them to diversify with IVOL.

As she said, the TIPS component of the fund does better if interest rates fall, but really it would not seem they can fall much more, can they?

She's been making the rounds. Does this mean that, as I heard Bill Bernstein say, if it's in the news, it's too late to make money with? Or is this a unique product that can be good for generating income (about 11% year to date)?
The bulk of the fund's return YTD is the return of SCHP (Schwab TIPS ETF) which comprised 87% of the assets in a recent snapshot; as also indicated by earlier graph in the thread comparing it to another TIPS funds.

If you look at the total holdings now it's pretty simple, 87% SCHP, some cash and a fairly short list of what all seem to be options on the 10yr v. 2 yr interest rate swap rate difference, maturing in 2021-2022. These would appear to be options which pay off if the curve gets steeper as in 10 yr interest rate swap rate minus 2 yr interest rate swap rate differential exceeds a certain threshold, the option strike it would be called. Broadly speaking the shape of the interest rate swap curve tracks w/ the shape of the treasury curve*. The treasury 2's v 10's spread was ~30bps at the beginning of this year v around 70bps now, so options on it widening will have have gained some value, or some purchased earlier might have expired in-the-money, though not a dramatic windfall. The notation for the holdings isn't explained but I guess maybe the final number might be the option strike in spread expressed in basis points (?). Anyway there's nothing really exotic going on, it wouldn't seem. It's just as the sponsors say, these are Over-The-Counter derivatives, there are no exchanged traded yield curve slope options. So, unlike various options/futures related ETF's which do stuff you could readily do yourself (eg. stock tail risk hedge ETF's that are just long exchange traded S&P index puts you could go long yourself, if your investing scale is reasonably large) this one is doing something few if any retail investors could DIY. But it's charging pretty much in expense ratio to do it.

*though the 'swap spread', interest rate swap rate minus treasury yield, in 10 yrs will tend to increase more than the spread in 2 yrs in a period of generally higher credit spreads. IOW the swap curve will tend to steepen more than the treasury curve in such a case.
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Re: How does the IVOL ETF work?

Post by GaryA505 »

JackoC wrote: Fri Oct 30, 2020 10:31 am
valleyrock wrote: Thu Oct 29, 2020 9:12 pm As noted above, one of the "selling points" Nancy Davis touts is access to the options market, which she says is valued at $22 Trillion, and she says this is where big time real estate investors hedge, but most people just own stocks and bonds, and it would help them to diversify with IVOL.

As she said, the TIPS component of the fund does better if interest rates fall, but really it would not seem they can fall much more, can they?

She's been making the rounds. Does this mean that, as I heard Bill Bernstein say, if it's in the news, it's too late to make money with? Or is this a unique product that can be good for generating income (about 11% year to date)?
The bulk of the fund's return YTD is the return of SCHP (Schwab TIPS ETF) which comprised 87% of the assets in a recent snapshot; as also indicated by earlier graph in the thread comparing it to another TIPS funds.

If you look at the total holdings now it's pretty simple, 87% SCHP, some cash and a fairly short list of what all seem to be options on the 10yr v. 2 yr interest rate swap rate difference, maturing in 2021-2022. These would appear to be options which pay off if the curve gets steeper as in 10 yr interest rate swap rate minus 2 yr interest rate swap rate differential exceeds a certain threshold, the option strike it would be called. Broadly speaking the shape of the interest rate swap curve tracks w/ the shape of the treasury curve*. The treasury 2's v 10's spread was ~30bps at the beginning of this year v around 70bps now, so options on it widening will have have gained some value, or some purchased earlier might have expired in-the-money, though not a dramatic windfall. The notation for the holdings isn't explained but I guess maybe the final number might be the option strike in spread expressed in basis points (?). Anyway there's nothing really exotic going on, it wouldn't seem. It's just as the sponsors say, these are Over-The-Counter derivatives, there are no exchanged traded yield curve slope options. So, unlike various options/futures related ETF's which do stuff you could readily do yourself (eg. stock tail risk hedge ETF's that are just long exchange traded S&P index puts you could go long yourself, if your investing scale is reasonably large) this one is doing something few if any retail investors could DIY. But it's charging pretty much in expense ratio to do it.

*though the 'swap spread', interest rate swap rate minus treasury yield, in 10 yrs will tend to increase more than the spread in 2 yrs in a period of generally higher credit spreads. IOW the swap curve will tend to steepen more than the treasury curve in such a case.
So, isn't this just a bet that the curve will steepen? Would the returns from the TIPS will be pretty-much wiped out by the ER, so it can't really make any money unless inflation jumps or the curve steepens?
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Re: How does the IVOL ETF work?

Post by JackoC »

GaryA505 wrote: Fri Oct 30, 2020 12:10 pm
JackoC wrote: Fri Oct 30, 2020 10:31 am
valleyrock wrote: Thu Oct 29, 2020 9:12 pm As noted above, one of the "selling points" Nancy Davis touts is access to the options market, which she says is valued at $22 Trillion, and she says this is where big time real estate investors hedge, but most people just own stocks and bonds, and it would help them to diversify with IVOL.

As she said, the TIPS component of the fund does better if interest rates fall, but really it would not seem they can fall much more, can they?

She's been making the rounds. Does this mean that, as I heard Bill Bernstein say, if it's in the news, it's too late to make money with? Or is this a unique product that can be good for generating income (about 11% year to date)?
The bulk of the fund's return YTD is the return of SCHP (Schwab TIPS ETF) which comprised 87% of the assets in a recent snapshot; as also indicated by earlier graph in the thread comparing it to another TIPS funds.

If you look at the total holdings now it's pretty simple, 87% SCHP, some cash and a fairly short list of what all seem to be options on the 10yr v. 2 yr interest rate swap rate difference, maturing in 2021-2022.
So, isn't this just a bet that the curve will steepen? Would the returns from the TIPS will be pretty-much wiped out by the ER, so it can't really make any money unless inflation jumps or the curve steepens?
I would say so basically. They say it's also a hedge against increase in rate volatility which would be true initially if the implied vol of the options already held when up, even if the curve did not steepen. But eventually it has to steepen for those options to pay off (a lot) at maturity. And I agree as long as inflation is below around 2%, and assuming -1% real TIPS yield at the 8 yr point (SCHP's approx avg maturity) the nominal return from the SCHP portion doesn't even pay the ER.
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Re: How does the IVOL ETF work?

Post by GaryA505 »

So I guess the mystery would be how the heck is it up 8.60% since it's inception until now (Jun 2019 - Sep 2020), when SCHP is up 9.15% for the same time period? It must have made a few bucks on the swaptions at some point.
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Re: How does the IVOL ETF work?

Post by nisiprius »

whodidntante wrote: Thu Oct 29, 2020 9:54 pm It's not even close to a record.
https://etfdb.com/compare/highest-expen ... %20rows%20
(It's a table of ETFs with expense ratios ranging up to 9.62%). (gasp) Thank you.
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Re: How does the IVOL ETF work?

Post by NoRegret »

GaryA505 wrote: Fri Oct 30, 2020 6:22 pm So I guess the mystery would be how the heck is it up 8.60% since it's inception until now (Jun 2019 - Sep 2020), when SCHP is up 9.15% for the same time period? It must have made a few bucks on the swaptions at some point.
You seem to be missing the distributions. Morningstar, from 5/13/19 to 10/30/20:
IVOL 14.89%
SCHP 13.33%

There’s benefit from taking profit from vol spikes. This is about optionalIty at flat to slight positive carry. Yes I wish its ER is lower.
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Re: How does the IVOL ETF work?

Post by JackoC »

NoRegret wrote: Sat Oct 31, 2020 2:11 am
GaryA505 wrote: Fri Oct 30, 2020 6:22 pm So I guess the mystery would be how the heck is it up 8.60% since it's inception until now (Jun 2019 - Sep 2020), when SCHP is up 9.15% for the same time period? It must have made a few bucks on the swaptions at some point.
You seem to be missing the distributions. Morningstar, from 5/13/19 to 10/30/20:
IVOL 14.89%
SCHP 13.33%

There’s benefit from taking profit from vol spikes. This is about optionalIty at flat to slight positive carry. Yes I wish its ER is lower.
There could be profit on the options, of course. But there's only lasting profit from implied volatility increases per se if you sell the options and don't buy new ones at a high implied volatility which later falls. In contrast to say the tail hedging strategy for stocks where you buy options *on* stock index implied volatility, VIX* options as in CBOE's VXTH index. If an S&P index option implied volatility spike (past the strike) lasts for the term of the VIX option, the option pays off. If instead I buy options on the underlying an implied vol spike is only a permanent profit if I can correctly time selling the options prior to expiry, otherwise profit depends on the option ending up in the money. If that point is too obvious sorry, I thought it might possibly be worth reiterating. Just evaluating the concept of this ETF rather than lamenting the high ER, it only makes money from the options over longer periods if a) the swap curve steepens past the strikes of the options for more than the premia paid for them or b) the 'significant expertise in the options market' of Quadratic, the manager, allows them to consistently monetize implied vol spikes by selling off the option positions at the right moment in an implied vol increase and not replacing them until implied vol goes back down. I'd be skeptical of anybody's ability to consistently add value in the latter respect for less than they charge to do it, and likewise skeptical of an individual investor's ability to sell and buy shares of the fund at the right moments to capture the value of vol spikes if the fund is holding the options to expiry.

The 2's-10's spread on the treasury curve (as proxy for the interest rate swap curve) steepened from 22 to 74 bps 5/13/19>10/30/20 so some of the options purchased presumably paid off if held to expiry, which could explain the fund's return without it having made any profit on implied vol changes by selling options prior to expiry.

*the VIX as we know is not literally the implied volatility of S&P index options but it's closely related.
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Re: How does the IVOL ETF work?

Post by NoRegret »

JackoC wrote: Sat Oct 31, 2020 10:21 am
There could be profit on the options, of course. But there's only lasting profit from implied volatility increases per se if you sell the options and don't buy new ones at a high implied volatility which later falls. In contrast to say the tail hedging strategy for stocks where you buy options *on* stock index implied volatility, VIX* options as in CBOE's VXTH index. If an S&P index option implied volatility spike (past the strike) lasts for the term of the VIX option, the option pays off. If instead I buy options on the underlying an implied vol spike is only a permanent profit if I can correctly time selling the options prior to expiry, otherwise profit depends on the option ending up in the money. If that point is too obvious sorry, I thought it might possibly be worth reiterating. Just evaluating the concept of this ETF rather than lamenting the high ER, it only makes money from the options over longer periods if a) the swap curve steepens past the strikes of the options for more than the premia paid for them or b) the 'significant expertise in the options market' of Quadratic, the manager, allows them to consistently monetize implied vol spikes by selling off the option positions at the right moment in an implied vol increase and not replacing them until implied vol goes back down. I'd be skeptical of anybody's ability to consistently add value in the latter respect for less than they charge to do it, and likewise skeptical of an individual investor's ability to sell and buy shares of the fund at the right moments to capture the value of vol spikes if the fund is holding the options to expiry.

The 2's-10's spread on the treasury curve (as proxy for the interest rate swap curve) steepened from 22 to 74 bps 5/13/19>10/30/20 so some of the options purchased presumably paid off if held to expiry, which could explain the fund's return without it having made any profit on implied vol changes by selling options prior to expiry.

*the VIX as we know is not literally the implied volatility of S&P index options but it's closely related.
Above underlined is, per my understanding, what most active vol managers try to do. Using a crude example which I'm sure is not doing it justice, a fixed allocation rebalance would accomplish exactly that: take profit when vol is high and replenish when vol drops back -- based on the well-known spike-and-decay behavior in vol. It is up to the investor to decide whether that rebalancing premium can overcome the ER of the fund.

Image

From Morningstar, ending 10/30/2020, IVOL : SCHP
From inception 5/13/2019, 14.89% : 13.33%
1y, 12.51% : 9.32%
YTD, 11:40% : 8.47%
6M, 5.88% : 3.81%
3M, 2.74% : 2.32%
1M, 0.44% : -0.64%

It would seem that so far the fund has managed to earn its keep. Granted the choice of dates has an impact as is the recent uptick in rates. Despite my misgivings about its ER, some SCHP is need for collateral, and the exact allocation and monetization strategy is precisely where the manager adds value.

viewtopic.php?p=5460933#p5460933
I disclosed owning this fund here. I have recently moved VTIP back to EDV but still have most of IVOL. It is very noteworthy that bond yields went up during last week's stock sell-off, along with the extreme short position in long bond futures. I don't know whether yields will snap back -- it's actually more consistent with my macro view. In that case, IVOL will face headwinds in the near term. However, longer term, we need to keep in mind where we are in the rate cycle.
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