Investors pile into funds betting on volatility

Investors are piling in to exchange-traded products, betting that stock-market volatility will increase from rock-bottom levels. But while they wait to cash in on a big spike, their returns are dwindling due to a quirk of the market.

- Bloomberg

The attraction is that if the record stock rally withers, market volatility will spike, delivering spectacular returns.

(BLOOMBERG)

The largest product that follows the performance of Cboe Volatility Index futures, the Barclays iPath S&P 500 VIX Short-Term Futures ETN, has increased assets by more than 300% this year to over $1 billion. The attraction is that if the record stock rally withers, market volatility will spike, delivering spectacular returns.

But these securities contain a trap for investors who hold them for too long: They burn through cash when traders think market swings will be greater in the future than now. And the more assets that flow into these products, the more gruesome these carry costs become.

Bloomberg Intelligence’s senior ETF analyst Eric Balchunas compares VIX ETPs to a “chainsaw”—very effective at certain jobs, “but it can cut your arm off.”