MacroShares Major Metro Housing ETPs: Changing the Housing Game

A smidgen of good news came with the release of the S&P/Case-Shiller Home Price Indices Tuesday morning. Although single family home prices continue to fall at an 18.8 percent rate across the country, the decline seems to be stabilizing. (chart 1) For the first time in 38 months the 10-City Composite index’s year over year performance improved from the previous month’s report. While “one robin” does not make it spring, let us hope this “robin” is soon joined by more friends.

I suspect this news will embolden housing Bulls, but there is plenty of data in the report for the Bears to snarl that investors should not be fooled by a slight up-tick. For instance, while the large California cities have shown improvements for a few months, New York had its first year-over-year double-digit decline since 1981 and is headed in the wrong direction.

Up until now, these confrontations between housing Bulls and Bears have been mostly academic, but that is about to change. On May 11, a new product will start trading allowing investors to wager on where these indexes are headed in the longer term. The housing index space has seen new products fail before, and this new entry is complicated, but I think the MacroShares have a decent chance of success.

In very simple terms, there are two shares: the Major Metro Housing UP (UMM) and Major Metro Housing DOWN (DMM). When the product was designed each share was worth $25 and together the pair is worth $50. Based on yesterday’s Index of 154.70 (chart 2), the UP shares now have an underlying value of $21.55 and the DOWN shares $28.45.

If the Index goes up from its initial value of 162.17 between now and the product’s expiration in November 2014, the assets from the DOWN shares will pay the UP shares 3 times the percentage increase in the Index based on the initial $25. Alternatively if the Index falls, the UP shares will pay the DOWN shares a similar amount.

Let’s run through an example. The initial Index level is 162.17 and both shares start at $25 and will be worth $25 if the Index is at that level in November 2014. If the Index increases 10 percent from 162.17 to 178.39, the DOWN shares will pay the UP shares 3 times the 10 percent change or 30 percent of $25; which equals $7.50. With the additional $7.50 the UP shares will be worth $32.50 ($25 + $7.50) at expiration while the DOWN shares will be worth only $17.50 ($25 - $7.50).

The underlying mechanisms of these shares, when paired together as one UP and one DOWN share, is similar to Exchange-Traded Funds (ETFs). And like ETFs, the paired shares should equal their “Paired Trusts” Net Asset Value (NAV) of $50 and therefore pairs of shares can be created and redeemed. However, while the pair will trade at the NAV, the individual UP and DOWN shares do not need to trade at their respective NAVs and in fact, the success of the product depends on them trading on future expectations, not today’s NAV.

Some investors may remember a similar product that was based on the price of oil. One of the problems with that product was that most investors did not realize the “market” price was where investors thought oil would be when the shares expired in 20 years and it was not designed to tract the spot price. Hopefully, with more education on the Housing Shares and making the expiration much shorter, these problems can be overcome.

The offering price ranges are $13.20-16.50 and $33.50-36.80 for the UP and DOWN shares respectively. The midpoints of these ranges ($14.85/35.15) imply an Index level in November 2014 of 140.22. This is 13.5 percent below the initial Index level but only 9.4 percent below the Index’s most recent level. (As a shorthand calculation, as long as the Trust’s combined NAV is exactly $50, every $1 change in the share price equals 2.1624 Index points.)

As I hope is clear, investors need to be careful and understand that the price of these shares represent expectations, not the current Index levels. If you think the Index will fall from its current level of 154.70 and buy the DOWN shares at $35.15, you will only make money at expiration if the Index closes below 140.22. However, in the meantime if “expectations" improve or deteriorate the shares may offer other profit or loss opportunities.

The underlying Index is the S&P/Case-Shiller Composite-10 Home Price Index (SP/CS Comp-10) which measures single-family housing prices in the country’s 10 largest cities. The index weights cities by the value of their housing stock and almost 50% of the Index is accounted for by New York (27.2%) and Los Angeles (21.2%). At the other end of the spectrum is Las Vegas which receives a lot of attention, but only has a weight of 1.5%.

The S&P/Case-Shiller Indexes use a technique called “Repeat Sales Methodology” for measuring the change in home prices. When a home is sold “at arms length” they look for the previous sales transaction of that exact same house and calculate the change in price with a few minor adjustments if necessary. Investors should note that foreclosure sales “at arms length” are included in the index; while newly built homes are not included as there is no “previous” sale. More information on the index is available on the S&P website.

The Index, published at 9:00 a.m. on the last Tuesday of each month, is a rolling three-month average and released with a two-month time lag. So for example, the data just released on April 28 was for the three-month period of Dec/Jan/Feb.

As with any new structured product there are a number of issues investors should be aware of and preliminary prospectuses are available at MacroMarkets’ website. The site also has information on the fund’s relatively rich 1.25% expense ratio and the details of the initial IPO process via an auction system which starts April 28.

Some of the critical concerns for investors will be the shares’ liquidity and bid/offer spreads. When futures contracts on this Index started trading a few years ago, things started out pretty well, but then faded quickly. MacroMarkets hopes the IPO process and Dutch auction will rectify these problems. For instance, the IPO will not be launched without substantial demand. In addition, the Dutch auction process insures some “price discovery” prior to listing.

On the Dutch auction, although the public will be kept in the dark during the process, (unless a re-filing is required due to a significantly revised price range or some other reason) investors should monitor the auction results closely and see if any opportunities pop up.

Investors who plan on actively trading the shares should also understand the seasonality of the Index. Home prices tend to get a boost in the 1^st half of the year and slow down in the 2^nd half. Obviously, none of this matters at expiration, but it can be important when analyzing trends from month to month. For instance, for the release on June 30 it will be good to know that June’s published Index has shown an increase in the rate of change versus the previous month in 17 of the last 21 years. On the other hand, January’s release has shown a decline in the rate of change vs. December in 20 out of 21 years.

As explained above, any gain for the UP or DOWN shares is funded by the other fund on a leveraged basis. Since the losing fund can eventually run out of money, the whole structure will shut down and terminate if the Index moves more than 33.3 percent (outside the range of 108.12 to 216.22) for three consecutive months and either the UP or DOWN shares will get all $50. If the Index gets close to either limit, but especially the lower one in the foreseeable future, expect traders to shift their focus from the likely Index level in 2014 to the probability of an early termination and as they do the DOWN shares may move quickly toward $50. I am not predicting future Index levels, but if prices continue to fall at their recent rate of about 19%, the Index will reach its lower limit in February of 2011.

Disclosure: Ed is long individual home builder stocks and home builder ETFs, none of which are named.

Comments

[Ron Rowland:]

...and if the index changes by 33.3% or more between now and maturity, one of the pair will go to zero.

These are not ETFs, not ETNs, nor CEFs. They are MacroShares. It is not possible to arb the price to the NAV, they will trade at premiums and discounts. The NAVs will be based on stale data (the February Case/Shiller data was just announced and it is almost May).

All other MacroShares have either put themselves out of business by going to zero or they are on ETF DeathWatch.
investwithanedge.com/e...

DOY had zero volume three out of five trading days last week. Buyer beware.

Apr 29 10:15 AM

[Eric van de...:]

You need to be very careful with the expenses on Macroshares. Their expense ratios appear to be fantasy. The current up and down oil macroshares list expense ratios of .95%. In fact, each trust has quarterly expenses of roughly $200,000 on principal of $10,000,000 and 1,800,000 shares outstanding for each. This comes to about 11c/share per quarter. On the up shares(UOY), currently trading at $3.10 that is an annual expense drag in excess of 14%. The expenses come out of the NAV on a daily basis.

Apr 29 03:03 PM

[Ed Hynes:]

I'm not sure how to respond to your first comment. It's just a fact that I hope it was well explained in my piece.

I agree with you that MacroShares are not ETFs and early this morning, I asked SA to change the title they incorrectly put on the article I titled MacroShares. Check out my instablog with the correct title.

You're also right you cannot arb the individual shares to the index, but who cares, as the goal of the product is to let investors buy and sell based on their expectation of where the index will be in Nov. 2014. Just like stocks are not tied to a company's book value, these are not tied to the index.

The question on the staleness of the index data is really not central to the product as I have just said the shares are supposed to trade on expectations. But, it will be interesting to see if the shares react when the index is published over the next few months. If the shares don’t move or have more volume than on a normal day, I will agree with you that the data is stale and in the market. However, if we do see movement and/or volume, I assume you will alter your opinion. Or, at least let us know beforehand how the stale data will move the shares so we can all make some money on the "stale" data. Deal?

As you know, in order to keep the UP and DOWN shares in syc and allow the shares outstanding to respond to greater or weaker demand, a creation/redemption mechanism for a pair of shares (one UP and one DOWN) at the “paired” NAV is in place and allows the necessary arb. This also allows the structure to be tax efficient for longer-term holders, just like in an ETF, no matter the coming and going of other shareholders.

The duel Trusts (UP & DOWN) with a Swap agreement between them is also tax efficient as “monies” are not settled up between the Trusts with each mont's index publication, only at the expiration.

Thanks for your comments.



On Apr 29 10:15 AM Ron Rowland wrote:

> ...and if the index changes by 33.3% or more between now and maturity,
> one of the pair will go to zero.
>
> These are not ETFs, not ETNs, nor CEFs. They are MacroShares. It
> is not possible to arb the price to the NAV, they will trade at premiums
> and discounts. The NAVs will be based on stale data (the February
> Case/Shiller data was just announced and it is almost May).
>
> All other MacroShares have either put themselves out of business
> by going to zero or they are on ETF DeathWatch.
> investwithanedge.com/e...
>
> DOY had zero volume three out of five trading days last week. Buyer
> beware.

Apr 29 04:41 PM

[Ron Rowland:]

The essence of what makes an ETF an ETF is the ability to force the price to track the NAV through the ability to perform in-kind creations and redemptions.

That is also what makes ETFs and ETNs such great products. This structure overcomes the dificiencies of closed-end funds.

ETNs are often based on 30-year notes, but they do not trade based on what investors believe the value at maturity will be.

I do not believe that any person that ever bought a MacroShare belived they were buying the anticipated price at maturity. The maturity date has never been mentioned before. However, since there is no creation or redemption taking place, perhaps that is what they are doing.

The current MacroShares spin machine says nothing about buying and selling based on perceived 2014 values. It is supposed to be a real-time method of tracking home prices. Howeve, becasue of its design, it will not track the index and will therefore not track home prices.

Perhaps there is a place in the world for a product such as the one you are describing, but they need to more fully explain that these are not ETFs, are nothing like ETFs, and will never be like ETFs.

Apr 29 06:35 PM

[Ed Hynes:]

In response to Ron's second comment on 4-29 at 6:35 pm:

Ron, with all due respect, have you read the prospectuses? Nothing says ETF. This is not an ETF. It is not a tracking product and as I say in my article, its success depends on the UP and DOWN shares not tracking the index. And, I hope you agree being a "structured product," but not necessarily an ETF is not automatically a bad thing.

If you think the product will fail and investors should stay away, which is a perfectly legitimate point of view; you will need to invent a new Deathwatch category as this is not an ETF!

In fact, in the “retail” road show presentation on the web that’s available to everyone, MacroMarkets articulates how the MacroShares are similar and dissimilar to ETFs.

The website also offers a tool (which I think could work better) at helping investors understand the index over time and how they might value the UP and DOWN shares on their expectation of the reported index level on November 25, 2014 for the three months ending September 2014.

I join most investors (and maybe you) in not "understanding" the MacroShares Oil product. I thought it was a tracking product and had no idea it was based on expectations out into the 2020s. How ridiculous!

But looking through the “Housing” material I had no problem seeing it was based on the index in 2014 and was not a tracking product. I actually thought it was a brand new variation after the “failure” of the oil product.

I don't know if this product will work and I am pretty critical - but it seems to be innovative at taking variations of some of the more attractive features of ETFs (creation/redemption tied to the “pairs’” NAV to keep it in line; and protecting investors on the tax side from investors moving in and out), adding a features of an ETN (it settles into the index with no slippage) and a swap between the two Trusts that allows leverage; only settles at expiration to avoid flows which might generate tax bills; and maybe helping (although I am not completely sure) with OID (Original Issue Discount) rules.

BTW, did you want to agree to the deal about the “staleness” of the index?

Cheers – I look forward to more discussion. EH

Apr 29 09:29 PM

[Paul Franc:]

I strongly advise anyone who ever considers investing in this utter piece of c$ap to look at the comment Eric made above. I have been in their "products" ever since their first oil one and have made a ton of money out of them, but not from the underlying movement of oil, but from the sheer stupidity of other suckers who invested in their scams. Here's exactly what happened/will happen:

1) Their scam products have hidden fees of $1.2 million PER YEAR. The fee is fixed regardless of how much the treasury they hold yields and is ON TOP OF THEIR 0.95% annual fixed fee. This amounts to 20% annual cost just in fees bleeding out of their funds every day. The market clearly is not interested in their scam and their AUM is at a meager 18M combined. AND they say in their marketing that their funds have no hidden counterparty risk!! What a bunch of lies!

2) They claim on their web site and every possible literature that their fund tracks the underlying index, which it does not. In fact their oil funds tracked nothing (the correlation to front month oil which they claim to track is? 0.35!). Just to give you a perspective YAHOO stock "tracks" oil better than their funds do.

3) HERE'S THE FRAUD: They claim their funds traded 3 million shares a day in 2008. GUESS WHAT? Their funds traded less than 1000 shares every day in 2008 until April, when they suddenly and secretly announced that their funds WILL TERMINATE IN JUNE. Therefore their funds would be killed in 3 months and no one knows it except for some big hedge funds which they notified in secret. At that time their UP OIL was trading at a huge discount and at the same time their down OIL was trading at something like 100% premium. Therefore the hedge funds started to arb this against futures like crazy. I spotted this due to a very sudden increase in short interest to a ridiculous level in their down oil on the very day their funds "announced" the termination. Therefore I bought up oil and sold short USO, also shorted their down oil like crazy. This is a risk-free arb that the hedge funds and me were able to exploit crazily creating huge vol. The public who wanted to short oil is then sucked in and bought their down oil "product" oblivious to the fact that it had turned into an option. Sometime in June their scams terminated leaving the down oil at --- ZERO. Since I was able to get almost unlimited amount of liquidity in their down and up oil I could only imagine the pain felt by investors who were sucked in to the scam. This was blatant market manipulation and the ridiculous thing was that they used this as a marketing tool for their next scams!! (Including these housing ones!!). But remember, there is no way to hedge housing this time, so the arb opportunity does not exist, so don't expect a free ride like the oil one. A perfect example would be their follow up scam--the UOY and DOY oil shares. Since this time no retail suckers wanted to short oil since it was so low, there was no demand for market manipulation and their funds are trading 0 shares. DEAD. This will be the fate for their housing funds since no one can hedge a position in those and there won't be any free rides even if they play the termination trick again. Their UMM and DMM will trade 100 shares a day and be dead in a quarter.

The macro market people are liars and cheats who should (if not have been) be investigated by the SEC. And you wanna buy a "product" from them? Go right ahead.

Apr 29 10:45 PM

[CavemanFore...:]

I believe that UMM and DMM will infact move based on where the Case Shiller is moving in the short term. The 2014 thing does not mean it won't move as the current Case Shiller moves. If you look at any long term futures contract, it may have a premium or discount over the front month contract but the long term futures contract will still move up and down with the spot/front month contract.

Whatever price a person things the Case Shiller will be in 2014, if the index drops 10 percent this year, that expectation for 2014 has to move if that person did not expect a 10 percent drop this year and then the UMM value would change.

The other thing that I think will make it move short term with changes in the Case Shiller is the provision that it will be cashed out if the Case Shiller gets to one of the boundaries that gets to 100% gain and -100% on the ETP's. Because that is the case, the closer the Case Shiller gets to one of those boundaries short term, investors will price in the chance that it will get to a boundary and never make it to 2014. So the price in 2014 may not ever matter and I think that will be a driving factor in keeping the ETF's tracking the Case Shiller short term.

I am real interested to see this start to trade and see what it does, but I am in the camp saying it will track the Case Shiller for the most part.

On a side note, pertaining to comments about UOY not tracking crude, I totally disagree. Here is a perf chart from stockcharts comparing crude to a few different oil etfs. stockcharts.com/charts...?$WTIC,OIL,USL,USO,UOY

It looks to me like UOY tracks crude just as good as any of the other oil etfs. There are times when one or the other gets off track from the relationship but the overal trends seem intact for all of them including UOY.

I think one reason UOY is suffering from low volume is because of how competitive the oil etf market is, there are lots of oil etfs especially when considering all the doubles and triples.

The UMM and DMM will not suffer from that problem as there are no other ETF's that come close to tracking home prices.

May 14 10:06 AM

[John Lounsbury:]

Ed - - -

Sorry I missed your fine article before I wrote my SA and Real Money articles. I, too, have problem with editors, here at SA, as well as at TheStreet.com, changing my titles and making editorial changes that I would not approve. In my Real Money article, I carefully called UMM and DMM investment trusts; the editors referred to them as ETFs, as did the SA editors when they changed my title.

In my analysis (Real Money), I suggested that there should be an automatic closeout point short of the five year maturity. I suggested maybe a 25% CS index move (75% in the trusts). If the closeout change was hit, the trust would be terminated and the assets distributed. We'll have to wait for the prospectus to see if they incorporate this feature. I feel the trusts have an Achilles heel if they don't do that.

The link to my Real Money article is www.thestreet.com/stor...

I see we are still waiting for the IPO.

Jun 11 11:33 PM