Why we invest in ziv and not in xiv

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Why we invest in ziv and not in xivWhy We Invest In ZIV And Not In XIV

By SeekingAlpha. October 02, 2013, 10:50:21 AM EDT

Several times I have been asked why we invest in [[ZIV]] (inverse mid-term volatility) and not in [[XIV]] (inverse front month volatility) in our " Maximum Yield Rotation Strategy " and in the "Global Market Rotation Enhanced Strategy."

After all, front month VIX Future contango is about 2-3x bigger than medium term contango. At the moment, XIV profits from nearly 9% monthly VIX Futures contango. ZIV profits from about 3% monthly VIX Futures contango.

Normally you would think that XIV should have a far better performance than ZIV, but now look at this chart of the 1 year performance. ZIV has performed very well. With 64% annual performance, it performs nearly 4% better than XIV and this with much less volatility.

The main problem is that both of the ETFs are inverse ETFs. This means that underlying they are constructed by shorting VIX futures. These ETFs are rebalanced every day and this results in a quite big time decay. XIV has a very high volatility of about 55% compared to only 25% for ZIV. Higher volatility means also bigger time decay losses.

The 25% volatility of ZIV fits very well to the volatilities of our global market ETFs (MDY, FEZ, EEM, EPP, ILF). Rotation strategies work better, if the ETFs have more or less the same volatility.

Rotation Strategy backtests

If I backtest our " Maximum Yield Rotation Strategy " with XIV instead of ZIV, then I only get an annual performance of 31% with a volatility of 48% since 2011. With ZIV, I get 70% annual performance with only 27% volatility. This is a huge difference, which shows you, how important it is, that the ETFs of a rotation strategy fit well together.