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ETFs Horizons revamps ETF amid worries about volatility-based funds

Concerns are growing around leveraged volatility-investment products as one of Canada's largest exchange-traded-fund providers announced a halt in trading for a second time this year.

Midday Tuesday, Horizons ETFs Management (Canada) Inc. announced a temporary suspension of new subscriptions for units of BetaPro S&P 500 VIX Short-Term Futures Daily Inverse ETF (HVI), saying it plans to rejig the fund's investment objective.

It is the same product the company halted on Feb. 6, a day after the Dow Jones industrial average fell 1,175 points, or 4.6 per cent, in a plunge that was partly attributed to products tied to volatility.

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HVI is tied to the CBOE Volatility index, known under the ticker VIX and referred to as Wall Street's "fear gauge"; it is also the reason HVI saw most of its assets wiped out in less than a day.

The ETF products tied to the VIX are extremely complex. Some are leveraged ETFs that typically aim to deliver two or three times the return on its stated index. Horizons ETFs is the only provider of leveraged ETFs in Canada, with 25 leveraged funds on its shelf. The majority of people who buy leveraged funds are self-directed investors with short-term investment horizons, and they are warned within the fund's investment prospectus about the risks involved with this type of investment.

Horizons, in a statement, said it was looking to amend HVI's investment objectives.

"After the close of trading today, it is anticipated by the manager that the performance of HVI will only correspond to approximately one-half times the inverse (opposite) multiple of the daily performance of the S&P 500 VIX Short Term Futures Index."

The changes to the fund come on the heels of two U.S providers, REX Shares and ProShares Advisors, also announcing changes to the investment objectives of their volatility funds – a move Bloomberg ETF analyst, Eric Balchunas, calls the equivalent of "neutering the funds to possibly appease the regulators."

"The funds will still be allowed to live, but they won't be as aggressive," Mr. Balchunas said. "For investors who use these products, everything is going to be a bit less intense. The older version of these funds used to be the equivalent of picking up nickels in front of a steamroller, but now the new version is like picking up a penny or two and the steamroller is smaller."

On Tuesday, ProShares Advisors announced it was also making changes to the investment objective as of the end of the trading day, which would reduce leverage on its Short VIX Short-Term Futures exchange-traded fund (ticker SVXY) and Ultra VIX Short-Term Futures ETF (ticker UVXY).

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BlackRock Asset Management Canada says that such leveraged products shouldn't share the same ETF label as more plain-vanilla funds and is calling on regulators to take a closer look at how these products are being marketed to investors.

Alan Green, the head of iShares Canada Capital Markets, says that investors are usually expecting broad, diversified exposure in their ETF, whether it be in equities, bonds or commodities. And they expect a payout of one-times whatever basket of securities the fund tracks.

"They are certainly not expecting daily resetting leverage or inverse payoffs," Mr. Green added.

He says providers of leveraged and inverse products shouldn't even have ETF in their name. If it was taken out, it would serve as a trigger to investors to take a closer look at the product's fact sheet.

This lack of awareness around the extreme volatility of the VIX also put a halt in one Canadian ETF provider's plans. Evolve chief executive Raj Lala had been considering launching several funds in the leveraged ETF space, but has since decided to take a step back and reconsider.

"I just don't know if people fully understand what they are getting into with this kind of product and they could be a tool that could lead to potential portfolio breakdowns," Mr. Lala said.

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