Core Viewpoint - Investors are flocking to exchange-traded products (ETPs) betting on a rise in market volatility, but a specific market mechanism is causing their returns to diminish despite increasing asset management in volatility-related products [1][3]. Group 1: Investment Trends - The largest product tracking Cboe Volatility Index (VIX) futures, Barclays iPath S&P 500 VIX Short-Term Futures ETN, has seen its assets under management grow over 300% this year, surpassing $1 billion [1]. - The appeal of these products lies in the potential for significant returns if the current record stock market rally fades, leading to a spike in market volatility [1]. - However, long-term holders of these securities face hidden traps as the cost of holding increases with inflows, leading to a severe erosion of returns [1][5]. Group 2: Performance Analysis - Bloomberg Intelligence's senior ETF analyst Eric Balchunas likens VIX-related ETPs to a "chainsaw," effective in specific scenarios but potentially harmful if not timed correctly [3]. - For instance, an investment in a volatility ETF before a major market event could double in value within a week, but holding the fund for a year could result in a loss of up to 78% [3][4]. - Current performance data shows significant losses for various VIX-related ETPs, with UVIX down 78% and VXX down 32% since September 26 [4]. Group 3: Cost and Strategy - The cost of holding these tools is significant, with the UVIX ETF having an expense ratio of 2.8% and engaging in a strategy of rolling over VIX futures contracts, which leads to continuous capital erosion [8]. - The strategy involves selling near-month contracts and buying next-month contracts, which can widen the price gap and further increase holding costs [8]. - Historical precedents show that similar products have previously underperformed compared to their underlying assets, as seen with oil ETFs a decade ago [8]. Group 4: Market Dynamics - As the stock market rises, implied volatility remains suppressed due to low actual market fluctuations, leading traders to be reluctant to pay high prices for volatility options [9][12]. - The current VIX futures curve is in a contango state, indicating that near-term futures are priced lower than longer-term futures, which presents arbitrage opportunities [12][15]. - Strategies that involve shorting the near-term VIX futures while going long on the next month are being employed, but they carry risks, particularly if the stock market experiences a sharp downturn [15][16].