Why did a radical new product allowing speculation on house prices fail?
Back in the summer I wrote about new products in the US that allowed investors and speculators to take positions on the housing market. Just six months later they've been wound up.
So what went wrong for MacroShares Major Metro Housing Up (UMM) and MacroShares Major Metro Housing Down (DMM)?
Not exactly fitting the description of ETFs or ETNs, these 'paired ETFs' simply invested their funds in Treasuries and cash, and were committed to transfer asset values from one fund to the other corresponding to changes (or multiples of changes) to the underlying index.
The funds are fully collateralised, i.e. their values are fully backed by cash, rather than depending on the credit worthiness of counterparties, and the idea could be applied to indices that don't have investable underlying assets, such as economic indicators.
This seesaw arrangement was the brainchild of Yale economist Professor Robert Shiller, who also devised the S&P/Case-Shiller house price indices on which these particular paired ETFs are based. His MacroShares company has also provided two pairs of similar products based on the price of crude oil, both of which have also been wound up.
So what went wrong?
Despite being heavily promoted and closely followed -- Time magazine named them one of the best inventions of the year -- the products were greeted by buyers with resounding indifference. As interesting and elegant as the idea may be, investors just didn't buy them.
Initial plans to launch $150m of shares in each fund were scaled back. One of the many early redemption clauses was the option for wind up the funds if they did not achieve a minimum of $25m in each fund; by December there was only about $11m in each fund, so the company pulled the plug.
The small size of the funds meant that fixed costs were spread over a smaller base than initially anticipated, and trading in the shares was not very liquid.
There has been negative comment in the press regarding the funds trading at a premium or discount to their underlying values, but it should be noted that they were never intended to track the market. In addition to the 3x 'leverage' -- actually the funds don't borrow, but the transfer of value is three-times the change in the index -- the price also reflects where investors expect prices to be when the funds terminate.
Where now for paired ETFs?
Shiller is going to try again, with slightly modified products to be sold to professionals rather than retail investors, but possibly to include Joe Public at a later stage.
While I like the thinking behind these products, I have to wonder if they really have a future. When a pair of funds based on housing fails to attract business, even in the most sophisticated and second most property-obsessed economy in the world, then I fear the future for paired ETFs doesn't look too bright.
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