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Minyan Mailbag: What's Wrong with the ETFs?


Nothing - daily discrepancies are normal.


A question I got after the close on Tuesday:

"I don't understand how those ETFs work. I know they don't track long term, but they should at least track 1-day performance as intended. Today's action is:

  • XLF +12.12%
  • IYG +11.38%
  • IYF +9.49%

Leveraged ETFs:

  • UYG +21.39%
  • SKF -20.01%
  • FAS +27.44%
  • FAZ - 29.59%

"So they don't provide 2x, -2x, 3x or -3x. Besides, if UYG is +21.39, shouldn't SKF be -21.39% - and the same with FAS/FAZ duo? They don't follow the benchmarks and don't even match each other? What's wrong with them?"

Lots of moving parts in the explanation here, so let's dig in.

Leveraged financial ETFs attempt to track some multiple of the 1-day change of the Net Asset Value (or NAV) of an index. They do not track another ETF. SKF attempts to track -2x the 1 day percentage move in the Dow Jones Financial Index. UYG attempts to track 2x the percentage move.

IYF is the regular ETF that tracks that Dow Jones Index.

ETFs don't exactly meet their goals, although the slippage is generally very light. More relevant for this discussion, though, is that they don't always close right at NAV. As a result, you'll see discrepancies within each day. SKF, UYG (or both) probably didn't close right at NAV yesterday, nor will they today or tomorrow or the next day. Nor will either likely close exactly -2x or 2x IYF, as IYF too will close at premiums and discounts to NAV every day.

FAZ and FAS track -3x and 3x the Russell Financial Index. So add all those minor tweaks above -- and throw in that Russell won't move to the penny with the other financial indices -- and FAZ and FAS will diverge slightly as well.

Throw in all these variables, mix in a big move in financials, account for the fact tht UYG and FAS trade at very low dollar amounts, and that a penny here and there represents a measurable percentage change in the day's move, and you get a situation where the normally slight discrepancies become more noticeable.

There's no "there" there, however. There's no arb in these observations, because if there are real pricing discrepancies, actual arbs will resolve them in about 3 seconds.

No positions in stocks mentioned.
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