New MacroShares Up / Down Housing Funds Don't Really Track Case-Shiller

by: Ron Rowland

Two funds, MacroShares Major Metro Housing Up (UMM) and MacroShares Major Metro Housing Down (DMM) began trading today. Do not buy these products until you have read and understand the prospectus, especially the parts where it explains that they will not track the underlying Case-Shiller index.

There is widespread misunderstanding as to what these securities actually are. Marketing literature and the April press releases issued by MacroMarkets state “the securities are designed to track the change in U.S. Home Prices as measured by the closely-followed S&P/Case-Shiller Composite-10 Home Price Index.”

According to other reports, the funds are designed to deliver +300% and -300% of the return of the S&P/Case-Shiller Home Price 10 Index. These marketing slogans have many investors believing that the new MacroShares are great products.

I believe those statements are extremely misleading. There is no asterisk pointing to the disclosures. Here are just a few of the reasons why these securities will not track the S&P/Case-Shiller Composite-10 Home Price Index:

  1. The S&P Case-Shiller Index is updated only once per month and released at 9am EST on the last Tuesday of the month. The prices for UMM and DMM will not change just once per month; they fluctuate dramatically all month long and will therefore not track the monthly index.
  2. When the S&P Case-Shiller Index is updated and released each month, it is based on home prices for two to five months prior to the release date. For example, this morning’s (June 30, 2009) index release was for home prices in February 2009 through April 2009. The prices for UMM and DMM will fluctuate dramatically all month long and will not wait for months in an attempt to track the index. Do you really believe that these MacroShares are tracking an index that contains housing prices from February?
  3. MacroShares are not ETFs and the trading price cannot be forced to track the underlying value through arbitrage and in-kind exchanges.
  4. The fact sheet boasts that this non-tracking characteristic is actually a “feature” and that the trading price be at a premium or discount reflecting investor expectations.
  5. The fact sheet further states that “MacroShares prices naturally diverge from underlying value.”
  6. The prospectus states the “Underlying Value” should track the index, but the market price will differ from the underlying value.
  7. Supply and demand cannot be separately maintained for UUM and DMM, since they can only be issued and redeemed in pairs.
  8. The 1.25% expense ratio (or $150,000, whichever is greater) plus $600,000 in annual fixed fees will create additional tracking error.
  9. There are 13 early termination triggers that could preempt the planned maturity in 2014.
  10. Don’t take my word for it. Read the small print on today’s press release where it says “An investment in a MacroShares Trust will not resemble a direct investment in the asset being tracked.” (emphasis mine).

The indicative values that the MacroShares will not track are designed to follow 3x (and 3x the inverse of) the return of the S&P Case-Shiller Composite-10, an index comprised of real estate sales from San Diego, Los Angeles, San Francisco, Las Vegas, Denver, Chicago, Boston, New York, Washington, DC, and Miami.

In reality, only when the trust expires on November 25, 2014 will owners of the new MacroShares be able to receive a value tied to the Case-Shiller Index (minus five years' worth of fees and expenses). Fees = 1.25% or $150,000 per year whichever is greater, plus fixed fees of $600k.

These products were expected much earlier in the year but faced many delays. The initial underlying value is being determined by the index value of 162.17, which was the published value of Feb 24, 2009 (representing home prices in October, November, and December of 2008). However, the index value has been subsequently revised to 162.11 introducing yet another reason for tracking error.

The Case-Shiller Index values and their subsequent revisions are: 3/31/09 = 158.04 (revised to 157.96), 4/28/09 = 154.70 (revised to 154.60), 5/26/09 = 151.36, and today’s 6/30/09 = 150.34.

Therefore, according to the fact sheets, the underlying values at inception are $29.98 for DMM and $20.02 for UMM. According to my calculations, the underlying values should be +/- 21.9% (3x the change from 6/30/09 index to 2/24/09 index value), or $19.53 for UMM and $30.47 for DMM. However, as outlined above, the shares will not track the underlying values.

Early termination will occur if the index range of 108.11 to 216.23 is exceeded prior to maturity, as one of the pair will have an underlying value of zero. There are a total of 13 early termination triggers listed in the prospectus.

The first trades have now gone through: UMM 1,000 shares at $20.03 and DMM, 900 shares at $30.87.

Additional information:

Disclosure: I have no positions in these securities and I do not receive any compensation or consideration from the advertising and marketing efforts of MacroMarket or MacroShares.