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If you’ve read Irrational Exhuberance, you may recall reading about Robert Shiller’s aspirations to create liquid markets to allow for hedging of real estate assets. Now, that dream is reality. Shiller’s company MacroMarkets has created two products which allow anyone with a brokerage account to trade the wider US housing market.
Although they may look like ETFs, these are really derivative constructs, so tread carefully. Technically they are an ETP or Exchange Traded Product and come with a hefty MER of 1.25%. By now, we’ve become used to double and triple leveraged ETF products. So it won’t be a stretch that the MacroShares ETPs are triple leveraged to the underlying index they track.
The MacroShares products, UMM and DMM, have been trading for 5 days, and already made a 19% move:
The MacroShares Major Metro Housing Up (UMM) and the MacroShares Major Metro Housing Down (DMM) will be tracking the S&P/Case Shiller 10-city composite index. Although you may think at first that it would only be necessary to have one product, which can be held either long or short, it is necessary to have two because of the nature of the asset.
The MacroShares don’t actually hold houses as assets, but rather short term Treasury bills. They track the value of the S&P/Case Shiller Index through a simple mechanism: they shift assets between each other to reflect the underlying changes in the index every day.
The two securities are held in trust until November 25th, 2014 - at which point the trust will be terminated and the liquidated assets returned to the holders of the securities. So if you think that from today until about 5 years from now, the Case Shiller Housing index will be higher, you would purchase the MacroShares Major Metro Housing Up (UMM). MacroMarkets plans to issue similar 5 year forward securities every year (depending on the reception of this initial pair).
You may wonder: since they have triple leverage, what would happen if housing prices were to fall or rise 33% or more? In such a case the shifting assets between UMM and DMM would reflect the fall or rise but stop when either one is at zero. If the condition persists, both will be liquidated.
As the trusts are holding interest bearing US Treasury bills, they will use the interest income to offset the MER. In case the income is larger than the management expense, it will be distributed to the holders of the securities. If it is not, then the value of the securities will be reduced.
Another wrinkle is that while there is an underlying value to the reference index, the price at which the two securities will trade is really up to demand and supply on the stock market. So just like a closed-end fund which may trade at a premium or discount to net asset values, DMM and UMM may diverge from their underlying value. In such a case, there is no mechanism which would re-align the two (other than the stated end date of the trusts in 2014). MacroMarkets does provide a “Fair Value Estimator” to calculate what the end value of the securities will be under different assumptions of home value appreciation.
Two previous products from MacroMarkets, set to track the crude oil market, had to be liquidated last year when the crude oil spiked in a mini-bubble. During the short life of the products they saw wild gyrations from their underlying value.
Using past data, the Case Shiller Home Index has very low correlation to other assets. Its correlation to REITs, a kissing cousin, is only 0.34 - although its return is about double, with less than a quarter of the volatility! But keep in mind that what is being traded is not exactly the index.
You can get more details about UMM and DMM at MacroShares.
What is ironic is that while the whole purpose of these two securities is to allow individuals and institutions to hedge exposure to real estate, that is to sell short and potentially neutralize a developing bubble, there is nothing to stop these securities themselves from being taken over by ‘irrational exhuberance’ of one kind or another. Funny things happen when you put float something on a freely traded stock exchange.
It’ll be interesting to see how this new market develops and what other products enter it. It is a bit meaningless to see granular movements in real estate prices on an hourly or minute basis, but that’s what we have now. MacroMarkets has made a valiant attempt to provide a valuable product but it has many shortcomings and can’t be considered a perfect hedge.
I know that you’re much too smart to take investment advice from a blog and that you do you own due diligence. Having said that, my suggestion is that these types of securities are way too new and way too complex to be used as a hedging instrument. It is ironic because of their creator’s original intention but probably their best use may be as a short term trading vehicle (especially when you consider the 19% rise in 5 days time).
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