Recap 3-19-12

Main Items:

  • NAHB Index was unchanged at 28 in March vs 30 exp.

Overseas:

  • EU finance officials may raise the combined capacity of the EFSF and ESM from 500bn euros to 700bn.

Upcoming Data:

  • Tues: UKCPI, US Housing Starts,
  • Wed: Japan Merchandise Trade Balance, BoE Minutes
  • Thurs: EU Flash PMI’s, US Jobless Claims

Commentary:

For those that are unaware, several ETN’s have traded substantially away from their NAV’s over the past couple months. TVIX, a 2x VIX ETN is now trading ~50% above NAV:

GAZ, a Natural GAS ETN, is trading ~140% above NAV:

These do not appear to be arbitrage opportunities. VelocityShares / Credit Suisse, the TVIX manager, has apparently stopped creating ETN units, citing risk limits. I wasn’t able to find news for iPath / Barclay’s, the manager for GAZ, but I’m assuming that there is a similar halt on ETN unit creation. Note that in both cases, the disconnect to NAV occurred after a sharp jump in shares outstanding. It appears that both managers have decided that it is not worth continuing the management of the ETN. As a result, instead of closing down the ETN and returning money, it will continue to simply collect the management fees. Presumably, their hope is that people will lose interest and allow the shares outstanding to revert to ‘acceptable’ levels.

Since there is now no mechanism for the ETN price to converge to NAV, these ETN’s are essentially close ended funds that have been subject to massive short squeezes. This means that unless there is conviction on when the ETF unit creation process will be restarted, risk/reward for these assets are highly uncertain. Note that the usual mechanism for arbitraging deeply discounted close ended funds is via activist positioning. But given that these ETN’s are trading at large premiums to NAV, this tactic isn’t feasible.

Finally, I am not a legal expert and have not gone through the 300 page prospectus, but why aren’t there some lawsuits on this? Readers are welcome to comment. In the meantime, this should provide a lesson to all investors regarding the risks of using ETN’s to replicate exposure. Caveat venditor, especially with respect to Credit Suisse and Barlcay managed ETN’s.

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