Invest in the New Housing ETFs

Many financial planners do not include the client's home as an investment asset. It does appear on the balance sheet as an asset, the mortgage as a liablity and the difference contributes to the net worth. However, the equity a person has in his/her home has not been included in the investment portfolio. That is about to change.

Next week, two new investment vehicles will provide a way to include residential real estate, including your own home, as an asset class in your portfolio. Two new investment trusts, UMM (Up Major Metro Housing) and DMM (Down Major Market Housing) will debut on the New York Stock exchange, offered by MacroShares. These products have been designed by Prof. Robert J. Shiller (Yale University), the co-creator of the Case-Shiller home price indices. The products will follow, but not replicate in market price, the Case-Shiller Composite 10 home price index, an index that tracks the single-family resale housing markets in 10 major U.S. metropolitan areas.

Further details about these new investment trusts, including some case study scenarios of how these products might be used by home owners, and those who intend to buy a home in the future, can be found here.

For the millions who have lost major amounts on the recent purchase of homes, these products are too late to compensate for those losses. It is probably true that a large percentage of recent home buyers would not have availed themselves of these investment vehicles, had they been available, but if even a small percentage had, that would be a few less devastated balance sheets.

I learned about these new products yesterday in a webinar co-sponsored by Financial Advisor Magazine and MacroShares. Prof. Shiller spoke at the webinar about the new trusts. Some of the details he presented are reviewed here, along with my case studies.

Comments

[TinyTim:]

Jeez, John, homeowners have enough ways to get into trouble. I know farmers hedge their crops in the commodities futures markets and this is considered conservative. But at least they're fairly sophisticated businessmen.

Jun 05 10:36 AM

[CaptainJJack:]

I am always leery of ETFs that track things that do not have an underlying cash market.

I predict that not only will these not replicate their index, they will under perform their respective index by a lot, especially the short ETF.

Jun 05 10:48 AM

[John Lounsbury:]

Tiny Tim - - -

Most home owners will not use these investment trusts. A few will and benefit from hedging risk. The downside will be that they will also limit potential gains. What this will do for the few that use these instruments is allow them to include their home as an asset in their investment portfolio, something that many financial planners do not do today.

A much larger use of these trusts will be by builders and developers to limit risk. Again, they will limit windfall potential in return for protecting against bankruptcy.

Finally, investors can use these trusts for portfolio diversification. The Case-Shiller House Price Index has near zero correlation to many other assets classes and negative correlation to bonds.

Jun 05 11:32 AM

[Market Sniper:]

More good stuff, John! I hve always been of the optinion that one's residence should NOT be included on your balance sheet as an asset even if it is free-and-clear of liens. Unless your renting out rooms, the cash flow is always negative. True, you have the utulity value, but in these times, renting is a better deal. Costs less to rent than to own currently in most areas and that may continue for years. Do not see an upside in residential real estate for many years. You make a good case for market participation thru these new ETF's but like you say, few homeowners will make use of it to hedge the value of their homes and that may also be a good thing.

Jun 05 11:41 AM

[John Lounsbury:]

CaptainJJack - - -

These are investment trusts (not technically ETFs, although I am sure that most will refer to them that way) that are entirely invested in U.S. Treasuries. I have yet to see the prospectus, but I expect they will be largely invested in Treasuies with maturity exactly matching the duration of the trusts. There may be some very short-term T-bills to provide some liquidity, while avoiding interest rate risk. The Case-Shiller House Price Index will determine NAV, but the market price (after IPO at NAV) will be determined by daily trading. NAV will be reset every month when Case-Shiller Index values are determined (by survey of existing home resales). When sentiment is bullish on housing prices, UMM will trade at a premium to NAV and DMM will trade at a discount. The reverse will be true when investor sentiment is bearish.

The duration of each trust is five years. At termination, the assets are distributed based on the then current NAV values. If house prices have risen 20% in five years, UMM will be redeemed at approximately 120% of IPO price and DMM will be redeemed at approximately 80%.

I say approximately because redemption amounts will be reduced by operating expenses of the trust. The prospectus is not yet available so I do not have information on the operating expenses, including offsetting gains (or additive losses, should any occur) from the Treasury securities, including interest received.

You are correct to be suspicious of ETFs that "track" indexes. I am currently researching the question of tracking errors for ETFs; they can be significant. However, these investment trusts are not ETFs and the NAV values will not have tracking errors. They can (and will) trade most of the time at premiums or discounts to NAV, in the same way that classical closed end funds do. One significant difference is that these trusts have a determined liquidation date, when they will be required to be valued at NAV for distributiion.

Once the prospectus is available I plan to revisit these investment products again and will report back.

Jun 05 11:57 AM

[Whippet:]

Thanks for the good article, John! Are there plans to offer options on these funds? This could increase their hedge value through leverage. Are there any plans to offer futures contracts that track the Case-Shiller Index?

Jun 05 01:11 PM

[islandcreek:]

Oh great! Now it will be possible to have even a bigger bubble(or bust) in housing in the future as ordinary people pile into these ETFs like they did with oil last year. That's a comforting thought!

Jun 05 01:11 PM

[John Lounsbury:]

Whippet - - -

I can not answer either of your questions. If these are offered next week, as planned, the information you seek may soon be available. I'll try to address these questions when I report back after the IPO.

One note: Because these trusts mature in five years from the date of issue, they have some characteristics of futures contracts.

Jun 05 01:24 PM

[TinyTim:]

"Finally, investors can use these trusts for portfolio diversification. The Case-Shiller House Price Index has near zero correlation to many other assets classes and negative correlation to bonds. "

Thanks, John.
This got my attention. I'll pass it on.
Always interested in non-correlated investments.

Jun 05 01:31 PM

[HaavBline:]

I agree this can be consider the beginning of a new asset class. It will be useful for investors who use asset allocation strrategies.

As it is, probably not much use for traders/speculators, with NAV adjusted only once a month.

I do hope it enjoy popularity, which would then make it possible to bring more targeted products to market.

Jun 06 12:25 AM

[Ed Hynes:]

John:

Most of your information is correct. However small one mistake is (as you have correctly mentioned elsewhere) the products are leveraged 3 times. So if the index is up 20%, the NAV at expiration will be up 60%.

I put together some information when these products were expected to be offered a month or so ago that can be found at: seekingalpha.com/artic...

Cheers,

Ed

Jun 09 10:31 PM

[John Lounsbury:]

Ed - - -

Sorry I missed your fine article. I should have mentioned the leverage in this post. It was recognized in the case studies in the referenced links.


On Jun 09 10:31 PM Ed Hynes wrote:

> John:
>
> Most of your information is correct. However small one mistake is
> (as you have correctly mentioned elsewhere) the products are leveraged
> 3 times. So if the index is up 20%, the NAV at expiration will be
> up 60%.
>
> I put together some information when these products were expected
> to be offered a month or so ago that can be found at: seekingalpha.com/artic...
>
>
> Cheers,
>
> Ed

Jun 11 11:21 PM

[Mad Hedge F...:]

Only if you want to be taken to the cleaners. There is so much inventory out there it is unbelievable, yet the relentless tide of foreclosures keeps dumping more properties on the market. The sickness has metastasized to commercial real estate, which may be the next big shoe to fall. Look at the chart of the Case-Shiller Real Estate Price Index, which shows us back at 2003 price levels. If this were a stock, would you want to buy it? It is starting to take on the flavor of an all out capitulation. Only the 1990-1997 bottom looks safe. Stay away. Rent, don’t buy.

Jun 30 05:52 PM

[Bob Mayo:]

With no arbitrage mechanism to keep the values in line with the NAVs it seems more of a curiosity than a hedge. If there weren't so many early termination triggers one could use it as a forward-delivered contract, sort of like a future, but alas that is not the case.

Jul 01 01:27 AM

[nobby73:]

If there are only people wanting to go short housing, how will the managers hedge their positions?

Jul 01 02:46 AM