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First Trust Rolls Out Tail-Risk Hedge ETF

Olly Ludwig and Cinthia Murphy

First Trust, the Wheaton, Ill.-based fund provider known for its niche strategies that include an Internet fund, today rolled out an ETF designed to help investors hedge tail risk in an S'P 500 portfolio.

The First Trust CBOE VIX Tail Hedge Index Fund (VIXH), which will track the CBOE S'P VIX Tail Hedge Index, will consist of equities from the S'P 500 universe. It will come with an annual expense ratio of 0.60 percent, according to the latest regulatory paperwork detailing the fund.

It will include a “variable option overlay” consisting of one-month call options on the VIX Index in a strategy designed solely to profit from sudden volatility spikes, while at the same time offsetting losses stocks typically incur from such events.

The fund’s tail-hedging strategy, in this context, is an attempt to protect a portfolio against sudden, unexpected market action that usually leads to increased volatility, the company said in the filing. To do so, First Trust will look to the CBOE Volatility Index, or VIX—which tracks near-term future volatility—and determine the extent of the fund’s overlay based on the level of market volatility.

The fund’s theme is timely to the extent that volatility remains a big concern among investors, particularly in how it relates to Europe’s sovereign debt crisis playing out. The current period of recurring spikes in volatility has coincided with the rollout of a number of strategies that strive to ride the volatility wave while protecting assets.

Funds like Invesco PowerShares’ S'P 500 Low Volatility ETF (SPLV)—which isolates the 100 least-market-movement-sensitive stocks in the S'P 500 Index—offer different ways to express views on the volatility theme, and have resonated with investors. SPLV was launched in May 2011 and has gathered about $2.36 billion, according to data compiled by IndexUniverse.

iPath and Etracs are also among the providers in the volatility-related space, each having an extensive roster of ETNs that focus on volatility and the S'P 500. The biggest VIX ETN of all, the iPath S'P 500 VIX Short-Term Futures ETN (VXX), has more than $2 billion in assets.

The Strategy

First Trust’s ETF, VIXH, plans to own all securities included in the index, and it may also employ an options overlay strategy, which would enable investors to choose whether to receive a security at a predetermined price and time, the company added.

The options overlay is the protecting feature for times of volatile market action. The possible use of derivatives was in the strategy was noted as a potential source of risk for investors, the filing said.


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