VelocityShares&8217; daily inverse volatility fund XIV has only been around since November 30th, 2010, but it has already delivered in a head turning 44% gain. This performance is not totally surprising given the collapse of VXX in the last two months, but how would it have behaved in less favorable times—let&8217;s say the Flash Crash?

I did a back synthesis of XIV starting January 4th, 2010 to get a feel for its longer term performance. Since its goal is to match the inverse daily performance of VXX this is a relatively straightforward task (at least compared to mind twisters like CVOL or XVIX). It&8217;s not as easy to get your head around as making investments at sites like BullionVault.com, but a backtest like this can give you a good feel for how an investment will behave. I did not factor in the 1.35% annual fee or treasury bill interest in my calculations. My results are shown below:

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Some observations:

- The XIV actuals (blue in upper right) and XXV actuals (orange data points), are landing right on top of my synthesized values. This gives me some confidence in my models
- If you could have invested in XIV at the beginning of 2010, you would have only been down 20% at the worst of the Flash Crash. This is pretty impressive given the dynamics of that correction. VXX jumped 80% during the Flash Crash, from 20 to 36.
- XIV would have climbed from 50 to 138, starting January 4th, 2010 and ending last Friday—a 175% increase in less than 13 months. Wow!

The fuel for this rocket is the fierce contango that VXX must deal with in rolling its volatility futures to provide a constant weighted average volatility maturity of one month. It&8217;s not set in stone that volatility futures will continue to have a steep increase in price with longer dated contracts, but it does seem to be a stable situation. If VXX and VXZ stop being the dominate ETNs in the volatility space this might change, but I don&8217;t expect that to happen in 2011.

For a link to XIV&8217;s prospectus see this page, which lists all active volatility ETNs/ETF along with links to their prospectuses.

Friday, July 22nd, 2011 |