Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 240

Cuffelinks Newsletter Edition 240

  •   16 February 2018
  •      
  •   

Before 2007, few people had a clue what a Collateralised Debt Obligation (CDO) was. When cash funds that held CDOs froze redemptions as the market collapsed, the loss of confidence drove what became the GFC. Suddenly, not only was mainstream media explaining CDOs, but so did bestselling books and Hollywood movies, the highlight being Michael Lewis's excellent The Big Short.

There's a scramble now to explain XIV. Bring on Lewis's next book. One day after the CBOE Volatility Index (VIX) had its largest-ever one day rise of 116%, Credit Suisse announced it would close its inverse VIX note. This VelocityShares Daily Inverse VIX Short Term ETN (NASDAQ code XIV) lost 96% of its value on one day. It's arcane to most Australian investors, but this was a $2.5 billion listed note that many local traders enjoyed as it returned 150% per annum for the previous two years.



What happened? In brief, until the start of 2018, equity markets had enjoyed years of falling volatility. Traders used products based on the value of the VIX (the VIX is an index and cannot be directly bought or sold) to sell at say 20, and buy back at say 12 as volatility fell. The inverse note, XIV, traded on the market just like a share, and as the VIX fell, XIV increased in price. Where there's demand, Wall Street creates a product.

But many traders had forgotten about risk. As volatility returned to the market, VIX rose dramatically, and the inverse note, the leveraged XIV, collapsed.

This 'shorting volatility' strategy paid for many a Porsche out of trader bonuses. Discussion website Reddit has a 'Trade XIV' group with 1,800 members, which carried posts like: "How I made $356K on XIV in two years". Now it includes this post:

"I've lost $4 million, 3 years of work, and other people's money. I started with 50k from my time in the army and a small inheritance, grew it to 4 mill in 3 years of which 1.5 mill was capital I raised from investors who believed in me. The amount of money I was making was ludicrous, could take out my folks and even extended family to nice dinners and stuff. Was planning to get a nice apartment and car or take my parents on a holiday, but now it's all gone."

Many of the investors were friends and family. I have not attached the relevant link to Reddit because much of the language is crude.

I'll leave it to Michael Lewis to write the XIV book and explain backwardation, gamma and contango, given he will have about 300 pages. Then go watch the movie.

It's not investing. Volatility trading and the need to cover leveraged risk on XIV and other products probably accelerated the overall market decline. This activity infiltrates mainstream stocks and induces investors to panic in response to headlines and fear. Forces such as these and high frequency trading (where computers automatically issue orders and now comprise about 60% of US equity trading) can have a pervasive impact on everyone's portfolio. The consequences appear to have been contained this time, and despite the screaming headlines, the US share market is ahead in 2018 to date.

This week, we start with three leading Australian fund managers. Roger Montgomeryand Paul Moore explain how they are reacting to last week's market fall, while Jack Graydelves into the threat that Artificial Intelligence (AI) brings to the wealth management industry. Then global chief economist Joe Davis says Bitcoin is a poor investment (it might go to zero) but has potential as a cryptocurrency.

Infrastructure funds have moved well beyond being considered as 'alternatives' and into mainstream portfolios, and Ofer Karliner makes the case for listed over unlisted assets. Pauline Vamos argues that portfolio management is not the same skill as asset class management, and we look at how Australian superannuation differs from global.

This week's Sponsor White Paper from nabtrade describes an alternative way to borrow to invest in shares that removes the risk of margin calls.

Graham Hand, Managing Editor

 

Edition 240 | 16 Feb 2018 | Editorial | Newsletter

 


 

Leave a Comment:

banner

Most viewed in recent weeks

Raising the GST to 15%

Treasurer Jim Chalmers aims to tackle tax reform but faces challenges. Previous reviews struggled due to political sensitivities, highlighting the need for comprehensive and politically feasible change.

7 examples of how the new super tax will be calculated

You've no doubt heard about Division 296. These case studies show what people at various levels above the $3 million threshold might need to pay the ATO, with examples ranging from under $500 to more than $35,000.

The revolt against Baby Boomer wealth

The $3m super tax could be put down to the Government needing money and the wealthy being easy targets. It’s deeper than that though and this looks at the factors behind the policy and why more taxes on the wealthy are coming.

Are franking credits hurting Australia’s economy?

Business investment and per capita GDP have languished over the past decade and the Labor Government is conducting inquiries to find out why. Franking credits should be part of the debate about our stalling economy.

Here's what should replace the $3 million super tax

With Div. 296 looming, is there a smarter way to tax superannuation? This proposes a fairer, income-linked alternative that respects compounding, ensures predictability, and avoids taxing unrealised capital gains. 

The rubbery numbers behind super tax concessions

In selling the super tax, Labor has repeated Treasury claims of there being $50 billion in super tax concessions annually, mostly flowing to high-income earners. This figure is vastly overstated.

Latest Updates

Investment strategies

Trump's US dollar assault is fuelling CBA's rise

Australian-based investors have been perplexed by the steep rise in CBA's share price But it's becoming clear that US funds are buying into our largest bank as a hedge against potential QE and further falls in the US dollar.

Investment strategies

With markets near record highs, here's what you should do with your portfolio

Markets have weathered geopolitical turmoil, hitting near record highs. Investors face tough decisions on valuations, asset concentration, and strategic portfolio rebalancing for risk control and future returns.

Property

Soaring house prices may be locking people into marriages

Soaring house prices are deepening Australia's cost of living crisis - and possibly distorting marriage decisions. New research links unexpected price changes to whether couples separate or silently struggle together.

Investment strategies

Google is facing 'the innovator's dilemma'

Artificial intelligence is forcing Google to rethink search - and its future. As usage shifts and rivals close in, will it adapt in time, or become a cautionary tale of disrupted disruptors?

Investment strategies

Study supports what many suspected about passive investing

The surge in passive investing doesn’t just mirror the market—it shapes it, often amplifying the rise of the largest firms and creating new risks and opportunities. For investors, understanding these effects is essential.

Property

Should we dump stamp duties for land taxes?

Economists have long flagged the idea of swapping property taxes for land taxes for fairness and equity reasons. This looks at why what seems fairer may not deliver the outcomes that we expect.

Investing

Being human means being a bad investor

Many of the behaviours that have made humans such a successful species also make it difficult for us to be good, long-term investors. The key to better decision making is to understand what makes us human and adapt.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.