The exchange-traded-fund> industry has grown to a nearly $1 trillion force by letting people bet on whether the prices of stocks, bonds, gold and even real estate will move up or down. Now it hopes investors crave a product that bets these markets will just move, period.
Over the past few months, the industry has launched, or announced plans to launch, 10 exchange-traded products that track the stock market's volatility. Some of the riskier products try to double the returns of the Chicago Board Options Exchange Market Volatility index known as the VIX, and often called the fear gauge while others bet that volatility will fall. Analysts say the slew of new products is a case of success breeding competition. Barclay's created the first volatility-based exchange-traded note, which is similar to an ETF, in January 2009. The market was in spasms then, as panicky investors fled stocks in the midst of the financial crisis. Not surprisingly, a new product aimed at making money from volatility was a hit, and the Barclay's iPath S&P VIX Short-Term Futures ETN has since grown to $1.3 billion.
Ironically, the new products are hitting the market at a time of extremely low volatility. Scott Burns, Morningstar's director of ETF research, says the VIX tends to revert to its longtime average of about 20 roughly where it has been recently. (The index peaked at around 80 during the 2008 financial crisis and hit 40 during the flash crash last May.) Burns says the markets have been relatively calm lately because, despite all the potential problems with the U.S. economy or crises abroad, the problems are all pretty well known. "By now everyone is certain that there's a lot of uncertainty out there," he says.
Some financial planners wonder whether such financial instruments make sense for individual investors. VelocityShares, a start-up that runs six of the new volatility ETFs, notes that new products are geared toward "more sophisticated" investors. Rick Miller, the founder of Sensible Financial Planning in Waltham, Mass., says he can see a role for them in the portfolios of savvier investors. But he points out that for technical reasons, if investors own any of these products for more than a month, the returns might be quite different from those of the index they track. Skittish investors who can't stomach roller-coaster markets might consider avoiding this one. "If volatility is going up from here, then most likely the market is going down," he says.