Betting on fear can be a real horror show.
Returns this year for exchange-traded funds and notes that track the Chicago Board Options Exchange Market Volatility Index -- more commonly known as the VIX, or "fear index" -- have been downright scary.
The largest fund in this category, the $1.5 billion iPath S&P 500 VIX Short Term Futures ETN, lost 58% this year through June, according to fund-tracker Morningstar Inc. On average, funds linked to the VIX, excluding those offering amplified or inverse returns, fell 35% over that period. That compares to an 8% gain for the Standard & Poor's 500-stock index.
The VIX measures how shaky traders expect the market to be in the future, based on the prices of options contracts. When the index moves higher, these funds are meant to benefit.
Despite their overall dismal performance, the investments remain popular. Investors added $2.9 billion to VIX-linked funds this year, after pulling $280 million in 2011. Assets in the funds now total $3.5 billion, up 50% from January.
Analysts say financial advisers and individual investors are turned to these products as a way to protect their portfolios after last year's market volatility, when the Dow Jones Industrial Average posted more than 100 days of triple-digit-point swings. The VIX peaked at 48 in August after S&P downgraded the U.S. credit rating, about half the reading in October 2008. The index rose 18% at one point Monday, the biggest one-day increase of the year.
The first VIX-linked funds were launched in the wake of the downturn as an easy, liquid way to bet on market volatility itself; there are 30 exchange traded funds and notes. "It's something that will do well when the rest of your portfolio is getting hit," says Matt Reiner, a portfolio manager at Wela Strategies, an asset management firm in Atlanta.
Companies responded by pitching the funds -- there are 30 exchange traded funds and notes, all launched after the 2008 downturn -- as an easy, liquid way to bet on market volatility itself. "It's something that will do well when the rest of your portfolio is getting hit," says Matt Reiner, a portfolio manager at Wela Strategies, an asset management firm in Atlanta.
But Mr. Reiner and other investing pros say the funds make little sense for buy-and-hold investors. They're most profitable, they say, for tactical investors who snap up the funds during temporary spikes in the VIX. For example, when the VIX jumped from 16 to 24 in May, an investor in the iPath ETF gained 29%. "It's like buying car insurance," says Timothy Strauts, an ETF analyst for Morningstar. "The funds pay off when there is an accident or when the market drops suddenly."
Even active investors say timing such moves is difficult. Derek Hernquist, a tactical portfolio manager in Charlotte, N.C., says he bought the iPath S&P 500 VIX Short Term Futures ETN for some clients during the last week of June, after a disappointing U.S. jobs report and another round of bad news from Europe. Instead of rising, the ETN's price dropped 6% to $15 during that period.
To minimize losses, Jim Strugger, a derivatives strategist with MKM Partners in Stamford, Conn., says investors shouldn't consider these funds until the VIX rises to at least 20. It neared 19 on Monday. "These really need more volatility to make money," he says.