ReSolve Riffs with Nancy Davis about Convexity Trading, Inflation and IVOL

This is “ReSolve Riffs” – live on YouTube every Friday afternoon to debate the most relevant investment topics of the day.

An almost USD 2 trillion fiscal bill is moving ahead in Congress, while breakeven rates rose above the 2 percent mark for the first time since 2018 (with no signs of relenting). It is no wonder that inflation is now top of mind for investors. Uncertainty isn’t limited to whether it reawakens after almost four decades, but how it might manifest and how investors should protect themselves. This week we riffed with Nancy Davis (Managing Partner & CIO of Quadratic Capital Management) who manages the popular IVOL ETF, covering topics such as:

  • Her early days as a prop trader for Goldman Sachs, earning her stripes trading derivatives
  • What is IVOL: a combination of TIPS and interest-rate options
  • Using cash to manage duration
  • What is implicit in the shape and slope of the yield curve
  • The risk of outliving one’s means – the importance of protecting against inflation
  • ‘Backing up the truck’ when volatility is so low
  • Linear vs asymmetric – not all derivatives are created equally

Nancy shared her screen throughout the conversation and walked us through her general framework, including what she believes are some of the most relevant features to monitor when navigating the inflation and rates landscape.

Thank you for watching and listening. See you next week.

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Nancy Davis
Managing Partner & Chief Investment Officer
Quadratic Capital Management

Nancy Davis is the founder and managing partner of Quadratic Capital Management. Ms. Davis is the portfolio manager for The Quadratic Interest Rate Volatility and Inflation Hedge ETF (NYSE Ticker: IVOL).

Ms. Davis founded Quadratic Capital in 2013. She began her career at Goldman Sachs where she spent nearly ten years, the last seven with the proprietary trading group where she rose to become the Head of Credit, Derivatives and OTC Trading. Prior to starting Quadratic, she served as a portfolio manager at Highbridge Capital Management where she managed $500 million of capital in a derivatives only portfolio. She later served in a senior executive role at AllianceBernstein.

She has been the recipient of numerous industry recognitions. She was named by Barron’s as one of the “100 Most Influential Women in U.S. Finance.” Institutional Investor called her a “Rising Star of Hedge Funds.” The Hedge Fund Journal tapped her as one of “Tomorrow’s Titans.”

Ms. Davis is considered a leading expert in the global financial markets and writes and speaks frequently about markets and investing. She has been published in Institutional Investor, Absolute Return and Financial News, and has contributed articles to two books.

Ms. Davis has been profiled by Forbes, and interviewed by The Economist, The Wall Street Journal, and The Financial Times among others. Ms. Davis is a frequent guest on financial television including CNBC, CNN, Sina, Fox and Bloomberg. She is a sought-after speaker for industry events.



Mike:00:01:12Here we are, another Friday. Cheers everyone. We’ve made it through another week.

Rodrigo:00:01:18We did.

Mike:00:01:21You’re just going to do the water, Nancy.


Rodrigo:00:01:25And happy hour. Adam doesn’t even have any liquids to drink. What’s going on buddy?

Adam:00:01:32Yeah. I’m just unprepared.

Mike:00:01:35All right, well before we start let’s warn everybody that if they want professional investment advice to get it from somewhere else other than here. We’re gonna have a wide-ranging conversation and go in lots of different directions. So, we want the latitude to do so. So, with that, I will start the show. Go ahead Adam.

Adam:00:01:54Yeah, no I just wanted to welcome Nancy, for everyone who is watching. This is none other than Nancy Davis. Maybe Nancy give your bio so that everyone knows where you’re coming from and what you’re doing these days.

Mike:00:02:09Yeah, your career arc would be great. I think yeah that’s informative from that perspective for all of the listeners and watchers.


Nancy:00:02:16Sure, so I’m really happy to be here with you guys this afternoon. A nice way to end the week. I’m Nancy Davis. I’m the founder of Quadratic Capital. I founded the firm in 2013. So, it’s been a lot of fun to run my own business and innovate in the ETF space. I’m the portfolio manager for the IVOL ETF. I started my career before starting Quadratic, I spent most of my time at Goldman Sachs. I was at the firm for about a decade and I rose to become the head of credit derivatives and OTC trading for the internal Prop Team. So, no capital, no outside money it was just Goldman’s capital.

Adam:00:03:02Very neat. And then, how do you think that your career trajectory prepared you for the management of this type of strategy? Maybe what does the strategy do and what makes you uniquely qualified or experienced to do it justice?

Nancy:00:03:23So, the strategy is long convexity. It’s an inflation protected bond fund, but then we augment the measure of inflation away from just the CPI index. The big problem that we see with just using, you know many investors talk about inflation and inflation expectations, but they’re talking about the difference between nominal bonds and inflation-protected bonds. It’s sort of like saying, you know I’m going to have equity exposure but I’m only going to buy the Dow Jones or the TSX, it’s just index and so my expertise is really on the options side and what we do is we add options that are on the rates market. Because the rates market is a broader measure of inflation and inflation expectations.

We use long options which are long fixed income volatility, because it’s a very nice uncorrelated thing to own inside a portfolio. In my experience from Goldman was running cross-asset class VOL strategies. I think you know most regular investors don’t realize they’re short VOL with their mortgage exposure. Mortgages in the United States at least I’m not sure about Canada, but investors, homeowners can prepay whenever they want. So, a mortgage owner is actually short an option. We saw that there was a problem with fixed income portfolios and the search for yield and taking too much credit spread risk. So, the nice thing about running a firm and running a business is you can innovate, and so we actually created the IVOL ETF and listed it in May last year 2000. I’m sorry two years ago now 2019.

Adam:00:05:13It’s amazing that we’re in 2020 already. So, when you, 2021 Jesus. So, when you say the rates markets, you mean taking positions in like Fed funds, euro dollar, like different bills markets or like right up to kind of two years. What do you mean by that?

Rates Markets

Nancy:00:05:28Yeah, that’s a good question because there are like a million different interest rates, right. There’re policy rates, there’s SOFR, LIBOR, treasury curves, swap curves. Specifically, we have exposure to real interest rates because we use treasuries with inflation protection, the TIPS market. So, those are just US treasuries plus inflation that resets with CPI, and then we augment that with interest rate options and what we use are OTC interest rates. So, our fund is really an access vehicle, because there is no listed market. So, most people can’t access, you know you could trade a listed product or you could trade treasury options. But we use the OTC swaps market which is something that most investors can’t access on their own.

Adam:00:06:20Got you. So, maybe paint a picture for what your portfolio might look like. And I don’t know how granular your you’d love to go, but I mean just to give investors sort of a general sense of what the portfolio might hold from day to day.

Nancy:00:06:33So, 85% of the fund is US treasuries. We use the TIPS with inflation protection and then we use cash as a way of reducing the duration of that passive index. Then we own fully funded options. So, it’s a pretty simple strategy in the sense that they’re only you know not many funds have only three things in it with one of them being cash. But the options are pretty unique and something that, even though a lot of investors might have experience with all sorts of you know credit products and other strategies. A lot of people are not as familiar with options especially OTC interest rate options. So, it’s a nice you know, I think of it as almost like a mirror image of a mortgage.

If you think about a mortgage, it’s a, in the US at least it’s an agency obligation coupled with that short option. IVOL is a treasury obligation coupled with a long option and we actively manage the portfolios. So, when managers buy the ETF, they’re hiring us and the Quadratic team for our expertise with managing OTC interest rate options.

Adam:00:07:42Got you. So, that the TIPS portion, is that a TIPS ladder or are you targeting a certain duration or how does that look?

Nancy:00:07:50So, we actually keep it really simple. We are a total return fund, so we use a passive TIPS index. We use a 14 and a half billion-dollar treasury fund. There’s actually about 40 billion dollars of AUM in that one index, because there’s another ETF that uses it. So, it’s just a passive index fund. And then we use cash as a way of reducing that passive index duration, but it gives our ETF tons of liquidity and also it allows us to really embrace the technology. And that’s what I see ETFs are, as the technology for in-kind trading. So, we try to be very tax efficient with our fund and so we do most of our bond trading what’s called “in kind”. So, you know at least for 2020 the fund had zero capital gains, yay, which is pretty awesome. You know being we’re an inflation fund, we want to be we want to be focused on total return.

Covering Inflation Risks

Adam:00:08:49That’s great. I really like the idea of covering a broader spectrum of inflation risks. So, I’d love to learn a little bit more about how you think about that. Because we talk a lot about how the CPI and the PCE deflator and other inflation baskets are not necessarily representative of a typical investor’s consumption basket. Like you know if you’re hedged against CPI with TIPS or you’ve got a pension that is indexed to some inflation metric, there’s no guarantee that that inflation indexing or hedge is actually going to hedge against the type of inflation that you might experience, right. Depending on your income bracket, your lifestyle, preferences etc. You may be exposed to a broader spectrum or maybe even a narrower set of inflation type exposures. So, how do you think about that and how do you express that thinking in this product?

Nancy:00:09:47Yeah, so we do agree that you know, there are a couple problems with TIPS by themselves. Like one is the index measures all linked to that CPI basket, right. Which may or may not be the right measure and number two, they’re long duration. So, if we actually had inflation, the bonds will lose money in a higher yield environment. So, those were kind of the two problems we were trying to solve was A, you know giving another measure of inflation and inflation expectations. B, solving for what do you do with the duration and the TIPS portfolio. I think the third is giving access to the fixed income VOL markets. Because most fixed income investors are short volatility in their fixed income from the mortgages.

So, those were the kind of, giving a long VOL product and fixed income space giving exposure to inflation expectations not measured by CPI. And then, also trying to create a better product that could actually you know potentially work if you had inflation, you’d likely have higher interest rates. So, you don’t want to be giving up all your returns if you’re preparing for, I think of it as almost like if you own or rent a home or apartment and you have homeowner’s insurance or renter’s insurance and your house doesn’t burn down. You’re not like, oh man you know that was a total waste of money. And I feel like inflation protection is one of those things for investors’ portfolios, because you know nobody wants to outlive their wealth and CPI, there are a lot of downsides with it.

Number one, it’s one US government entity and that’s the Bureau of Labor Statistics who calculates this index. And currently today, you can go on to, you know if you just Google BLS and CPI you can see what’s in the CPI. But about a third of it is what they define as shelter, right. If you peel back then you’re like what the heck is shelter, it’s actually mostly urban rent. So, you know I don’t think at least most of our clients are like, well that’s not necessarily the thing that they’re super worried about. Especially with the pandemic and generally rent prices like at least in you know, we’re outside of New York City and you know rent prices are down to levels they were 10 years ago.

Adam:00:12:11Got you. Sorry I’m totally dominating this because I’m actually super curious. I’ve got like tons of questions.

Mike:00:12:21Keep going, you just keep going.

Rodrigo:00:12:23That’s fine, we were on earlier for another show, so you weren’t there, Go ahead.


Nancy:00:12:25You guys have been having too many sips of drinks tonight, right.

Adam:00:12:29That’s right.


Mike:00:12:32Everyone who knows me knows I’m very quiet and reserved.

Adam:00:12:35That’s right.

Adam:00:12:36Those are the adjectives; I’ve always used to describe you again.

Nancy:00:12:40Anyone who says that is lying.



Understanding Yield Curve

Adam:00:12:45Usually, your intuition is dead on there for sure. So, I guess the inflation hedge for IVOL if I have the mechanics right are predicated on that inflation manifesting in either a parallel move higher across the yield curve or an increase in the slope of the yield curve. Which of those are, is the strategy most sensitive to or let’s call it convex to? And then as a second part of the question and we’ll just start with the first one but I just so you know where I’m going. There’s been a lot of talk of sort of yield curve control and what they might call financial repression, right. Where inflation ticks up but the Fed keep, puts a cap on rates. So yeah, let’s start with sort of what are the sensitivities of this convexity in terms of slope versus just a parallel move and then

Nancy:00:13:57Yeah, so maybe first for your listeners let’s just take a step back. What the heck is the yield curve? Let’s just define that to say you know what is it. It’s definitely, so there’s policy rates which is what any central bank sets. You know in the United States the Fed sets the policy rates and then there’s rate expectations. Meaning when the rates market thinks the Fed would be hiking, for instance in the US they’re not really pricing in any hikes anytime soon. And then the yield curve is just largely a measure of inflation expectations in the future, because that’s a risk premium.

So, like today you know if you go out to a bank and you open up a CD, you know policy rates are close to zero. Maybe you get five basis points if you say how about I lock up my money for two years, you would get 10 basis points. And then if you say, how about a decade how about I lock up my money for 10 years, you would get paid a little over 1% to lock up your capital for 10 years. That’s because the yield curve is unnaturally low and that’s because a lot of people have been thinking, ‘Oh, they’re gonna do yield curve control and things are not going to be normalized’. So, that’s really the difference between short dated and long dated rates and it’s currently a little over 1% which is a very abnormal situation.

I think the best example I like to put, I mean talk about is 2013 policy rates in the US were still near that zero bound. But it was just normal that if you went to a bank and you locked up your money for ten years right, ten year lock up that you would get paid 2% plus a little bit. There was no fear of inflation, no average inflation spent targeting, no blue wave in the United States, no fiscal spending, no yelling in the treasury that was just normal. Today is not normal and that’s the kind of exciting thing for us with the IVOL ETF is, we don’t really need there to be some tail event or inflation. We just need a normalization in the rates market which you’ve really already seen in the credit and equity markets, right.

They’ve already priced in a recovery but still a lot of investors and rates don’t believe it, right. They’re all hanging out and you can see that with the level of you know, 10-year interest rates. Whether it’s 10-year treasuries or 10-year swaps, you know why in the world would you get paid you know 1%, when CPI is already higher than that, you’re basically locking in a negative yield. So, I think the yield curve is really largely that risk premia are largely a result of investors’ expectations for inflation in the future. So, hopefully did I…

Adam:00:16:47No, that was a really good background for sure. So, I think I’m reading between the lines here then that the primary exposure here or sensitivity or convexity of the options portfolio is to a steepening of the curve. And you’re less concerned with sort of a generalized rise in rates, right. The steepness of the curve reflects inflation expectations that that’s specifically what you are targeting a hedge toward.

Nancy:00:17:18Yeah, I mean a lot of people use those words but I think what it plays out to be is we want the widening between short and long dated rates. That’s another way, I think it’s easier and more intuitive for people to think about. Because especially most fixed income investors are used to looking at credit, right. And with you know anything that has a credit spread, whether it’s you know leveraged loans, floating rate notes, you know high yield bonds investment grade. You want the credit spread to tighten or interest rates to go lower to make money. With us, we’re long bonds so lower yields is you know especially lower real yields is good for our treasuries that we own. We have a lot of bonds. So, we don’t dislike low yields.


Nancy:00:18:00And then the options, they’re completely agnostic to the level of rates. absolutely like whether rates were positive 10% or negative 10%, they don’t care. they just want the spread between short and long dated rates to widen. So, I think comparing it to credit is like a little bit more intuitive for people to understand. because a lot of people like, when you say steepening of the yield curve and they’re like, ‘what is that?’ you know they have no idea what you’re talking about and so I think it’s more intuitive to talk about widening. And the neat thing is that widening can happen in a lot of different environments. You could have, say we have a huge risk-off environment. Say you know the vaccine doesn’t work you know its huge risk off, and the rates market starts to price in negative rates from the Fed.

That can you know widen the spread so it can be lower front dated yields or it could be like super risk on day. Like November 9th the day the vaccine was announced, the markets ripped right. Equities rallied, credit spreads tightened and anything that had duration whether it was short duration long duration, it didn’t matter. Anything that is you know even short duration strategies are still long duration, right. They’re just less long. So, all those strategies lost money you know TIPS were down about 30 basis points. IVOL was up 66 basis points that day, even though TIPS were down 30 and that’s 85% of what we own. So, the cool thing is the options don’t really care about the level of interest rates we just want it to widen. Is that certainly?

Rodrigo:00:19:37Yeah, and certainly the prior to COVID hitting the markets, we saw that it was fairly cheap in terms I was looking at the move index prior to the event. And of course, then it widened but it looks to me now that we are at like historic low VOL for interest rates again. Which is absolutely bonkers, right? So, it’s an opportunity to back up the truck and get as much cheap convexity in that trade as you can.

Nancy:00:20:03Yeah, it’s I call myself a Vega Monster because I just want to gobble it all up. We’re just we love all the VOL and the move index actually hit its all-time history of financial market lows on my birthday. I was like this is a gift from God you know.

Mike:00:20:21That’s awesome.

Nancy:00:20:22Yeah, and we don’t have the move index. The move index interesting thing about that index world is, it’s all from the equity side of the business. There’s not a lot of pipes into the rates market. It’s the same reason like why can’t you buy an ETF in a 401K account. It’s kind of stupid it’s just old technology, that’s why they all use mutual funds which I’m sure drives you all crazy, right. So, the index world is more legacy equity, so they need something listed in order to get prices. The move index is not you know its listed treasury options, so it’s not the same thing as what we have. But it’s the only index out there.

The cool thing about what we own is our volatility is actually lower than what that index is. So, it’s even cheaper to buy this inflation protection than what the move index is pricing in.

Profiting From Volatility

Adam:00:21:13I think it’s useful to, and you can obviously feel free to correct me, but I think what you were saying was really interesting, right. It doesn’t, you don’t need rates to go up to earn, to generate on your options portfolio. Short rates can go down and long rates can stay where they are. Short rates can go up but long rates can go up more. You know there’s a variety of combinations that would be beneficial to the positioning of the portfolio. And it just to sort of put the icing on the cake in the event that you’ve got an increase in VOL, right. So, of all sort of expressing the uncertainty of agents in the rate market, when VOL goes up you also benefit, right.

So, you’ve got these three levers and that extra that extra delta on the VOL is also nice. So, that’s interesting. We’ve got a couple of questions from the audience. So, Antonia asked, ‘Is IVOL – SCHP equal to the cost of a rate swap?’


Adam:00:22:30The answer expanding on the answer to that might be illustrative.

Nancy:00:22:34Okay, sorry.

Mike:00:22:36No, thank you for your question.

Nancy:00:22:38Antonia no, we obviously SCHP is a passive bond index that we do to be very to use that in kind technology when we’re trading our bonds. So, we don’t generate capital gains tax and try to be tax efficient. And then the options component is inside that, so you can compare you know here. Can I share my screen with you would that be okay?

Adam:00:23:07Yeah, please do.

Nancy:00:23:08I’m trying to show, because everybody wants to know like what’s the breakdown and we show that. Hold on one sec, I’m share screen and I went to monitor. I have a couple monitors. I want this monitor and okay. Can you see my screen?

Adam:00:23:30Well yes, we can.

Mike:00:23:31Okay, we see IVOL.

Nancy:00:23:32Better than just a, no, I’ll put numbers behind it. Here is the performance of the IVOL product versus the TIPS. So, you can see you know in numbers that no it’s not swaps. I’m like super anti-swaps, I don’t like linear instruments generally like futures forward swaps. They’re all derivatives and this is pretty interesting. I have a different way of looking at the world, but derivatives are you know it’s like fruit, right. It’s just lots of different types of fruit. We use options only and we want the asymmetry, because inflation can go negative, right. We could clearly have a deflationary. There is no zero bound and so if you had a swap, you would make a dollar, lose a dollar.

I think that’s really yuck you know especially with VOL being so cheap. Why would you want to make one lose one? So, we don’t use swaps, we don’t like swaps. A lot of people use inflation swaps, those are also yuck in my opinion because they’re linear and they’re still using that CPI. Let me just share again. I’ll just share my screen on my Bloomberg monitor one sec. So, can you guys see this? I’m going to make it bigger.


Nancy:00:24:53So, here you can see the five-year breakeven which is the difference between nominal treasuries and inflation-protected treasuries. It’s already 231 basis points. Like that’s not that exciting. And then if you look at the inflation swap market, here is the 10-year at 219. The 10-year inflation swap always trades at this premium to break evens and again it’s CPI inflation. It’s a linear product. It can go negative and you pay this premium, because there’s no natural seller of it. So, the banks will just mark it up. You see its trading today at you know,  you’re buying this at 230 basis points and B, you’re paying you know 20 basis point premium just to have you know an OTC counterparty risk.

Whereas what we own is this, is the 2’s 10 swap curve. This is I think a matter, it’s not a swap it’s an option on this. So, this is the difference between the 2 year and the 10-year rate. You can see back, in 2013 it was just normal. You know go to a bank, open a CD, policy rates were still you know under 50 basis points. You lock up your capital for 10 years. It was just normal to have you know 250. There was nobody was freaking out about inflation here. This was just you know we were coming out of the European debt crisis. We listed the fund; I’ll try to put my cursor on it. It was May 14 2019. I think I got it.

Okay, so the spot curve was 18 basis points. Today it’s 104. But you can see contextually it’s not like you know it’s kind of a yawn not much has happened yet. Here I’ll just go back to, you guys can still see my screen, right.

Adam:00:26:47Yes ma’am.

Nancy:00:26:48So, the fund is up, I can go to the monthly numbers. About a little over 21% since May 14 2019 when we listed it. I don’t have today for some reason. What is today? February 5th. So, 21.8 through today’s trading day. And it’s just you know nothing’s really going on, so we’re pretty excited about the opportunity. Because we think you know there’s a lot of normalization to happen and that’s not even saying, hey we’re going to have stagflation or there’s going to be inflation.

Mike:00:27:27I just want to, so that reflects the widening that you’re talking about. That you expect a just going back to normal would create the widening right, just to put it in the nomenclature that you had talked about earlier. Go ahead.

Nancy:00:27:46If you open a bank CD and you lock up your money for a decade, it would just be normal to get paid. You know if you think the inflation rate is going to be 2%, why would you ever lock up your capital and get paid less than that. That’s what I think is weird, that’s what doesn’t make sense to me. When auto rate people talk about inflation expectations, they’re talking about the breakeven level. Which again, I think it’s like saying I own equities and I own the Dow Jones. You know it’s just index, it’s one measure of inflation expectations. The Fed doesn’t even use it, so I don’t think it’s super relevant.

Rodrigo:00:28:23One of the things that interests me about options traders, because you know you have this long component to the portfolio. But correct me if I’m wrong. You’ve been trading options since you started your career, and I imagine you were mostly an options trader understanding the bleed that comes along with holding a position that doesn’t do what you wanted to do and so on. How do you deal with that? Do you do it systematically? Like I’m curious to know once the volatility expanded in March and you had to resolve. How do you handle re-upping your position on the options market when it’s so expensive?

Managing Options Bleed

Nancy:00:29:03So, the nice thing about the fund is it’s actively managed, because there is no interest rate volatility in inflation hedge index so there’s nothing to replicate. You get our expertise for managing you know Vega risk in this market. We can shift at any point whether you know I call myself a Vega Monster today, because VOL’s so cheap. I just load up the truck on it. We have you can see the average tenor of options inside the portfolio is 21 months, plus on average. They’re very very long dated options and that’s because I think it’s right to back up the truck right now. It’s a really cheap especially with everything that’s going on in the you know, real life.

Whereas in March, what we can do is we can use more high gamma options, shorter dated, options higher strike options for more convexity. So, you have the benefit of you know making an asset allocation saying, ‘Hey I want to have a way to have inflation, have inflation protection. I like having a long volatility product, because you know we’re not really correlated to anything else.’ Which is nice. Let me just share my screen with you all again, one sec. This one such a pain having multiple monitors and doing this. So, this is just our fact sheet and you can see this is the daily correlation of IVOL to many common indices. You can see we’re not correlated to the VIX, we’re not correlated to the AG, we’re not correlated to equities. It’s just something different and this is nice, because inflation is a risk on trade.

If we go back to the performance that I was showing to Antonia, you can see in March IVOL, we actually don’t have the month of March here. But IVOL was positive in the month of March, even though TIPS were down 150 basis points. So, we had less of a drawdown than TIPS by themselves. And then our recovery from peak to trough was four trading days versus TIPS by themselves. Took almost three months to get back from peak to trough. So, it’s a nice thing to own volatility because you get this, you know it’s not correlated to other things. Personally, I think that’s the reason like, why do people have, you know what’s the point of fixed income, what’s it supposed to do.

In my opinion it’s supposed to diversify your equity risk and that could be your private equity beta, your equity market beta. It’s all these portfolios the risk is in equities. And then the problem is we’ve been in such low rates for such a long time that investors have been pushed away from government securities into all sorts of I like to call it credit crap. That’s not the right very nice word, but they’re going into all sorts of things in the search for yield. Then you have like with credit, you have a similar beta to equity, right. Because credit spreads will widen when equities sell off. So, I think it’s a nice product because it gives that enhanced distribution or that potential for enhanced distribution.

Let me just show you again. We’ve been distributing 30 basis points monthly. Let me just show you this. Since the fund started paying distributions in that summer. Can you see my screen?



Nancy: 00:32:27 So, we actually paid out 50 basis points in December 2019, but 30 basis points a month minimum has been our monthly distribution. That’s nice, because investors have been going into all sorts of credit spread products in the search for yield. And IVOL doesn’t have corporate credit risk right, we have counterparty risk with the options. But it’s different than you know some of these products have all sorts of european banks and you know asset-backed securities and CMBS and CLOs and all sorts of generally credit spread risk. So, I think it’s a nice solution potentially for investors to say, look I want something that’s going to diversify my equities. I want to have that monthly distribution and I want to gain exposure to inflation, that’s not linked to that you know that one index.

Adam:00:33:26So, help me understand how a portfolio of TIPS. I mean what’s the indicated yield on the TIPS index at the moment? Let’s got to be in this.

Nancy:00:33:34That’s because TIPS reset with CPI. So, let me go back and share my screen with you all again, and we can bring it up. Okay, so we’ll go to, this is the passive fund that we use, the Schwab fund. You can see all these emitted discontinued blah blah blah TIPS reset with the CPI. And CPI over the course of most of 2020 was continuing to fall, because of the pandemic and inflation going lower and lower. So, there’s no guarantee, TIPS are a variable yield product and the distribution currently is 1.11% for the 12-month yield from this Schwab fund. We can also look at this one is the, it’s the same passive index.

This is the same Bloomberg Barclays Treasury Index, but you can see also lots of omitted and discontinued because TIPS are variable.

Adam:00:34:45Yeah, so I guess where I’m going is the so the historical yield has been, call it 1% plus or minus a little bit, right. But you’re distributing 3.5% per year. How do you close that gap in such a consistent way? That seems like a huge hurdle to overcome in such a consistent manner.

Nancy:00:35:03So, that’s from the options component obviously.

Adam:00:35:06You’re buying options, right.

Rodrigo:00:35:08 You must be shorting all the VOL, what’s going on.

Nancy:00:35:11No, I’m not shorting VOL. You guys are, you are equity VOL people right because you’re the only way to generate.

Rodrigo:00:35:18Totally confused, help me out

Nancy:00:35:20 Okay, so equity VOL yeah, there’s nothing you can do with equity options. If you own an equity option, you just bleed. It’s like every day you walk in you’re gonna lose a little bit of money you know probably 99% of the days and then maybe one day you’ll make a lot. But then it’ll mean revert back. So, the reason a lot of people sell you know anytime you see the word ‘right’, right is like a nice word for short volatility. So, put right, buy right, any of that sells equity options. This has nothing to do with equity options. We own interest rate options. But the cool thing about interest rate options is although you pay time decay, because you’re still long gamma, long Vega, long the convexity but you still pay theta. But we can have positive roll between the spot and the forward.

So, it’s somewhere more to like you know FX, a lot of Canadians love their carry in the FX market. What is that? That’s a rate differential right and that’s a carry strategy. So, I see the rate options market is similar to other type of carry strategies, where we still, you don’t sell naked options. We don’t sell spreads there are a lot of tricks that people do in the options world especially in equities where you know they might say, ‘oh or long VOL’. But they go sell a bunch of front dated options so they’re short gamma or they sell five all in one spot and they sell on another. This is very simple; this is a long only fund. It’s always long options. It’s just a question of which options were long and how much were long.

When we sell, we sell to close to profit take and we roll and the options are pretty unique. Because they generate ordinary income. Let me show you the Canadians I’m not sure, I’m not a tax expert I’m not giving tax advice. I want to do all my anything about.

Mike:00:37:19 There’s no advice here at all.

Rodrigo:00:37:17This is disclaimer.

Mike:00:37:18There is no advice here of anyone kind.

Rodrigo:00:37:21There’s also probably Canadians watching.

Mike:00:37:24You can stick to the American expertise.

Nancy:00:37:28 I’m not giving advice on America either. If you go and look at our fact sheet, you can see that options are not ordinary assets. I’m sorry, they’re not capital assets they’re ordinary assets. So, when we sell them for a gain, they generate ordinary income and that is different than interest income. If you look at like let’s see SCC yield, Gosh it’s zero. Why is that? That’s because TIPS this is through August 21, going back to here TIPS didn’t pay anything. So, there’s no interest income that’s why the SCC yield its interest income. The options generate ordinary income not interest income. So, that’s why this I think this is kind of weird, there’s nothing I can do though it’s it is what it is. But they’re not regular, you know most funds that use derivatives whether they’re futures, forwards, swaps all those things are considered capital assets.

So, they generate capital gains or capital losses. Ours are ordinary, so they generate ordinary income or ordinary losses. And the ordinary losses are not necessarily a bad thing either, because say you know, going back to the house analogy say your house, you have homeowner’s or renter’s insurance and your house doesn’t burn down at the end of the year. You’re not like disappointed about that. So, say the options all expire worthless over the course of the year, say nothing happens. So, there’s no interest rate volatility or inflation hedge and we underperform a regular TIPS portfolio. Let’s just say you know disaster node.

The options that we sell at a loss or options that expire worthless are actually negative income which is pretty cool. Because there’s no cap on that. Yeah, there’s no cap on how much negative income you can have. So, the fund is taxed on the fund level not on the individual level. But again, I’m not giving tax advice, but it’s a pretty the rates market is a really nice place to own volatility for the long term. Because it’s not always positive roll, but most of the time it does have very very benign if not positive carry. So, hopefully that answered the question.

Adam:00:39:552.5% a year.

Nancy:00:39:56 What?

Adam:00:39:57To the tune of like 2.5% a year, right?

Mike:00:39:59Some of that’s got to be skill.

Nancy:00:40:01Be what?

Adam:00:40:03Well, I’m trying to close the gap between the 3.6% annual like monthly distributions, right of 30 basis points. And the yield on the underlying TIPS portfolio and I know you’ve also got a bunch. There’s cash plus TIPS right, so you’re not getting the full 1.1% or whatever from the TIPS. It’s like whatever fraction of the TIPS portfolio. Yeah, so I guess what I’m saying is that, that roll yield is you can be confident enough that that will be at least call it 2.5% a year.

Nancy:00:40:42It’s not roll yield, it’s when we monetize an option. So, when we sell an option, it generates, if we just hold it mark to market, it just has mark to market. But if we sell it, it generates ordinary income and we are a registered investment company. So, we have to distribute our ordinary income, so that’s why I say a minimum of 30 basis points. Because say let’s take the say the house does go on fire. So, there’s lots of inflation or stagflation and the options like boom really kick in you know and we lock in profits. We’ll have a whole bunch of ordinary income which we will be distributing to our shareholders. So, it’s not a guaranteed thing.

Rodrigo:00:41:23The roll yield helps, but it’s the active management that really helps and you’re going to have to because you’re a … Okay, so it really is all about the long options portfolio that allowed you to check the distribution out. So, you know you kind of called us out for being equity long VOL guys, but three or four years ago -.

Nancy:00:41:50VOL people are always the hardest.

Rodrigo:00:41:52Jason Buck is on here, he’s really just livid I can sense it from his eyes, from his emoticon. You know when I met you three, four years ago in a Toronto hotel and we were walking down, you’re telling me that you had this massive Brazil trade on. I can’t remember what it was, but in my mind I imagine it was an equity trade. This was an options-based trade as well. So, have you always just focused on the credit market or have you done the whole gamut? What was that? Tell me about that Brazil trade, if I recall correctly it went really well?

Nancy:00:42:33So, I only trade options that’s the one thing. You know I do not like linear anything. I am an asymmetric girl through and through. So, no linear you know besides that the treasuries, the only thing we have treasuries. But I don’t like linear derivatives, no swaps, no futures, no options. So, I’m sorry only options no linear derivatives. I’m sure it was an option trade and I love; you know I think of myself as a professional convexity sniffer. And a lot of times you know when you have consensus that something is going to happen, usually taking a contrarian view is priced in a really cheap asymmetric way. So, I love to have contrarian views and I think I definitely do remember that specific trade.

I probably shouldn’t go into details on what that was, because that wasn’t in the fund that we’re managing right now. But my expertise is in options across all asset classes. I don’t do stocks that someone, I’m not a stock person. But with equities we would use country’s indices. And then, so we have experience in five asset classes, so rate options obviously that’s what IVOL is. FX options, so foreign currency all pairs. The credit markets as well. So, Swaptions and Tranches and things like that with convexity and then commodities. I love commodity options and then equities, but no stocks.

So, it’s all five asset classes and that’s very similar to what I did at Goldman as well. It was always cross asset class you know finding interesting convexities and payoffs. And that’s why out of all the choices of things to do you know five different asset classes. It’s a lot of stuff. I thought IVOL was a really great fun, because nobody was worried about inflation or inflation expectations. Nobody owned you know that, and I was like, wow that’s kind of stupid why would people not want to own that. You know it’s like nobody wants to outlive their wealth right that would be a disaster. So, I thought it was a good you know kind of, I hadn’t done an ETF before launching IVOL. But I was like, this is a good solution for our investors. This is a good problem because TIPS by themselves are not great and most fixed income investors are short VOL from their mortgages. Hope that answered the question.

Rodrigo:00:45:05Yeah Nancy it does. I just want to be clear that I don’t necessarily want to focus on, I don’t want the Vega Monster to be the only thing that we’re talking about. I want some of the convexity stuff to come out. We don’t need to focus on the IVOL ETFs


Rodrigo:00:45:18I’m really interested in your as the all the convexity stuff. So, unless there’s some reason why you don’t want to share the specific example of Brazil, just generally speaking.

Nancy:00:45:32I don’t have that on now. So, I wouldn’t feel comfortable talking about that.

Rodrigo:00:45:36That’s all good, I mean the big question with those type of trading that you do with options is that it’s very different than anything else. It feels to me like that type of trading leads to a lot of small losses small losses small losses and large gains. Just you’re not doing linear trades does your PNL look linear when you’re looking at your convexity book or is it choppier and jumpier.

Nancy:00:46:05Well, I can show you for IVOL because we have a public fund. So, you can see it and it’s not that choppy, I think it’s all to do with size right, size matters. So, it’s all about how much exposure how much convexity and it’s a little bit of art and a science combined. Because you want to have you know the right amount of convexity, but you don’t want something to be like a big swing right a big, options are a zero or one. So, I really like using longer dated options. I think most people in the options world especially in the equity world, they love to sell short dated options. Because they want their theta and they want it now right.

Their goal is to when you sell an option you want it to expire, right. The most you can ever make is the day that you sell it and so a lot of people sell short dated options. Because they want that high time decay and they want it now. So, most of the world in the options space especially in equities uses shorter dated options. I prefer longer dated options generally in most asset classes because then you have more time for things to play out, right. You don’t have to make a bet about, hey this is going to happen in a week or next month this is going to happen. So, I prefer longer dated options generally. I think a quick way to lose a lot of money is in short dated options. If you’re long or short, but short’s worst.


Adam:00:47:35So, I wanted to talk about some of the other ways that inflation might manifest right.

Mike:00:47:41Before we go there Adam, just one last small point of clarification. Because I do love that direction, but it’s a big turn. So, just 85% in TIPS, some amount of the 15% is managing the duration of TIPS and then some percentage of that’s left over is in the option book. Can you on average sort of highlight what that is? What is in the option book on a sort of general average over the duration? What’s in what’s in the option book? What percentage of the portfolio?

Nancy:00:48:16So, the nice thing about an ETF is it’s fully transparent. You can always see what it is and I love that about ETFs. I feel like the transparency is great. So, you can pull up like here we can go into Bloomberg and just pull up the description. You can see that you know about 85% is in the passive treasury fund and then we have this adds up to be a little under 6% in fully funded long-dated options. You can see the Vega Monster in me, because look at the tenors of these are long-dated options. Because I love buying the VOL. so, we run the portfolio and every day you can always see exactly what’s in the portfolio. You can see how it changes and how when we’re rolling and what we’re doing. So, typically on average, we’ve been running the range over the course of the fund’s existence has been 3% on the low side in terms of fully funded long options.

9% was the high side that was right after the fund listed in May 2019. It was like a baby fund. But typically, we try to keep it around but we don’t manage. We manage a couple of different Greek exposures, so we’re doing active management. It’s not just the market value of the options it’s not just a premium, right. It’s you know how long dated they are, what strikes do you own, what are their so there are a lot of different components to manage. That’s why we actually have a ton of Canadians who use the fund shout out to all my macro Canadian hedge funds, because a lot of them use it. Because they don’t have maybe Insta agreements on their own or even if they do they just don’t want the headache of dealing with like how do I book this, what do I do with it, how do I manage it.

They don’t want to be managing the Greeks exposure an excel spreadsheet. You can even really price these things in Bloomberg. So, we do have a lot of professional investors who use our product as a way of gaining access to this market. Did I answer your question?

Mike:00:50:26Well, absolutely fabulous. Over to Adam, sorry Adam for that interlude.

Adam:00:50:29No problem, yep. So, an options book on the two’s tens swap market, right. Yeah, okay. So, inflation right I mean just circling the wagon on this because I think especially a lot of our audience are interested in this. We talk a lot about that on the show and it’s definitely entering the zeitgeist as an area of potential concern, right. So, I’m just trying to think about the type of scenario. I mean I think we’ve covered off the types of inflation and the manifestations of inflation that the IVOL fund is explicitly designed to protect against, right. I’m wondering if you’ve got any thoughts on complements.

So, for those who are generally concerned about inflation and who are maybe concerned that inflation might have to leak outside the rates domain due to you know just general sort of government control. And you know you’ve played in the multi-asset space for many years. What are your thoughts on how to sort of complement this product with other potential inflation hedges?

Other Inflation Hedges

Nancy:00:51:47So, a lot of people use commodities or equities to gain exposure to their you know inflation and inflation expectations. Then you have a whole another segment in the private world that’s doing all sorts of like bizarro things like timberland and coffee plantations and illiquids. So, I would separate it between two like the liquid public securities which tend to be equities and commodities, and then the private securities. Which is you know all these at least in the US like these public plans have all sorts of like crazy things that they do. You know like nuts and coffee and you know timber to gain real asset exposure.

So, I’d say they’re two camps. On the liquid side, a lot of people will say oh you know certain equity sectors should do well there. You know maybe, maybe not. I think the big challenge is if we actually had inflation then the Fed might not be able to be on hold for as long as they can. And that potentially could make equity sell off. You know all investing involves risk and there’s no one-trick pony, right. Nobody you know we really haven’t had it since the 70s the one thing. I do feel confident that we’re not going to have 70s style inflation. Because personally I think oil you know its kind of like a laptop.

You know it’s just getting, technology is making it cheaper and easier to get out of the ground. I don’t really think we’re gonna have an oil shock like we did in the 70s. But I know a lot of people will buy oil or other commodities as an inflation hedge. Then a lot of people use gold or other precious metals and you know I get gold from a psychology trade. I get it from a you know a currency play. I don’t really understand it as an inflation trade, that to me doesn’t make a ton of sense because it’s actually a negative carry asset. You know Warren Buffet he said in the late 90s I’m paraphrasing. But you know if Martians were looking at the earth, they would think we were out of our mind to be digging it up in one hole. Melting it down, putting it in a different hole and paying people to guard it.

You know it’s kind of a, and gold especially if you have it in you know dollars or Canadian dollars it’s a negative carry asset. So, I don’t know if gold is a good inflation hedge. I definitely think it’s good for psychology and it’s good for FX. But I think it’s more of a not an inflation hedge in my point of view. But that’s what makes a market, and when people think you know a lot of people are buying cryptocurrencies and other things because they think it’s an inflation hedge. It’s really not what happens that matters, it’s more prices that drive these markets. You know I think the rates market is a very pure way of gaining exposure.

I’m like why mess around, like people are in bank stocks and equity VOL and having you know TIPS and all sorts of things. I’m like, isn’t it more simple just to use IVOL. I think we’ll accomplish that goal in a cleaner way and then you don’t be managing all these different things. But like anything you should diversify right, because you just never know, you don’t want to have all your chips on one thing.

Adam:00:55:15I like that. So, in a portfolio context then considering the different forms that inflation might take and then considering you know just the ambiguity about whether we’re going to see material inflation in our investment horizon. You know just acknowledging that the huge amount of uncertainty in the trajectory of economic characteristics and financial markets and sort of scoping out a diversified, truly diversified portfolio against all these major types of market conditions. What do you think a portfolio looks like and where does IVOL kind of sit in that? How would you kind of think about sizing it?

Nancy:00:55:58So, the one thing I’d say is, it depends how much you hate credit. You know that’s a weird way to start.

Adam:00:56:06We all loathe credit.

Mike:00:56:07We loathe it.

Nancy:00:56:09Yeah, I mean it’s funny because the more people hate credit the more, they’re like, oh I love IVOL. Like I have CIOs call me up all the time and they’re like IVOL 25% of my portfolios, should I make it bigger. I was like, I don’t know I’m not you know, sizing is not my thing I’m like a super specialist. But I think the investors who think defaults are going higher credit spreads are too tight, the rally in equity and credit is just nonsensical. They tend to have IVOL as a much bigger piece of their portfolio. Some people use it just as an inflation substitute, but it’s, I can show you here let me share my screen with you. We have on our IVOL website, there’s our materials tab and in here we have a presentation deck.

On page 9 and 10, we have a couple of you know classes of like we have a whole bunch of model builders who use IVOL. Most model builders in fixed income use the Bloomberg Barclays AG index. Even if they’re active managers, they’re benchmarked to the AG. The AG is the old index it used to be the Lehman AG. And it has about 40% as treasuries but it has no TIPS in it. TIPS were invented by the US Treasury, the inflation protected bonds in the late 90s. Then about a third of it is short VOL from mortgages. So, we have a bunch of these passive investors who are like, look we just want, we have no idea what’s going to happen. We just want to have a diversified fixed income and they use IVOL as a way to complete that passive fixed income exposure to give inflation expectations and to neutralize the short VOL of mortgages.

So, that’s been pretty popular as just a, you know completion portfolio. We do have some you know real estate people. I think IVOL is almost like opposite of a mortgage. You know it’s long an option and treasury portfolio instead of an agency obligation and a short option. Some people use it as a you know potential real estate hedge. It depends obviously real estate’s very local, Canada has been a very hot market. I do not know if it would be a good hedge in Canada or not. And then some people use it instead of having minVOL, lowVOL equities. I really hate that strategy’s name. They tend to be value-based stocks and people see them as defensive, because they’ve had historically less drawdown.

But they have really nothing to do with volatility, they just happen to have a lower standard deviation of returns. So, some people use instead of having like lowVOL minVOL, they’ll use IVOL as a way to actually have long VOL. Then on the fixed income side, we have a bunch of people that obviously replace it instead of just a TIPS portfolio.

Adam:00:59:02Its only about that one that seems like an obvious use case.

Nancy:00:59:04Yeah, it’s kind of like especially when you look at you know you go back to the level of like, well breakeven are you know 231 basis points and this is 104. You know it’s pretty obvious there to get diversify away from the Bureau of Labor Statistics CPI Index. And then some people use it for floating rate notes, because floating rate notes are mostly credit spread risk. The coupon resets higher with interest rates, but it’s not really the best. If they’re worried about higher rates, it may or may not be the best thing and then short duration has become really popular. We have a lot of people who use you know their in-short duration, because they’re worried about higher interest rates.

But the problem with short duration is short duration is still long duration, right. You are 100% guaranteeing that your investors your clients will lose money in a higher yield environment with short duration. And a lot of the short duration strategies have gone down the rabbit hole into all sorts of credit crap. You know they have all sorts of you know a lot of these indices have you know 80% of it is credit exposure. So, although it’s a short duration credit, you think about if you were a company right now a corporate, and you needed money, would you take a short dated loan? Like I wouldn’t.

Mike:01:00:29Give me the hundred years.

Nancy:01:00:33 Yeah, generally the crappy credits that use short-dated debt, in my opinion that’s my bias I don’t want to offend any corporates. But you know, why wouldn’t you turn it out. So, you look at a lot of these floating rates, you know it’s like short duration and yeah it might have a duration of less than a year. But the likelihood of that thing that Romanian bank going bankrupt is pretty freaking high. So, I think it’s been pretty popular with a lot of professional fund managers. Like a lot of endowments, in particular will use it as a replacement for short duration. Because at least we have the potential to make money in a higher yield environment versus being guaranteed to lose money. And then going back to the credit thing, the more they don’t want credit exposure the more they look at their short duration managers.

They’re like, holy cow it’s 85, 86% and they have all sorts of crazy things in there. You know a lot of these short duration funds will have CMBS or ABS, CLOs or european banks. All sorts of like in my opinion pretty toxic stuff to own in today’s environment. Hopefully that an answer.

Rodrigo:01:01:41From … cash management, I believe is what they call it.

Mike:01:01:45From a multi-asset perspective though if your concern is duration is your bond book even the right place to start looking, or should you be looking at your equity book.

Adam:01:01:58You mean you’ve got such a massive duration bet on your equity book, yeah.


Adam:01:02:04Especially with earnings yields where they are, yeah.

Mike:01:02:06Precisely, so if I’m an advisor or an allocator that has concerns about duration, there’s probably a more effective way to handle the duration in my equity book than there is in my bond book potentially.

The Clothes in the Laundry

Nancy:01:02:21Yeah, I think that the good point and everybody is worried about interest rates right now. That is a consensus thing and it’s priced fairly, right. You get paid nothing to own short duration. Like you take all this crappy credit spread risk and you get you know 30 bips a year maybe if you’re lucky. So, I don’t see the point. Personally, I’m like why bother I’d rather have you know IVOL cash and you know other stuff. So, I think short duration has been really popular, because a lot of investors just don’t have a good place to put cash. Because it’s a 40 Act Fund right, it’s literally intraday liquidity and a lot of our institutional investors will trade it at the nav. This is cool and I know you guys are ETF guys. It’s so interesting, the nav based technology.

Here’s my analogy I am, I think of trading in the secondary market, that’s the shares outstanding as like dirty clothes in the laundry, right. They’re go, they’re just going around in the bin, they’re just trading hands. The primary market is the, you can also use for ETFs  just like a mutual fund where you trade at the nav, ETFs have that as well. So, you can always use the primary market to do, it’s called a “Nav Based Create”. Look it’s my business card right here, I don’t know if you can see it. My business card and on the back of it, it has the three magic words which is called a nav. I can’t get the screen right now, NAV Based Trade.

NAV Based Trade is like the new magic words that I learned, because some of our institutional investors when the fund was super small, they’d put like 10-million-dollar market order and the thing would go, ‘Wow.’ There was no reason that it was going up so much. So, a Nav Based Create is the three magic words if you’re buying. Nav Based Regime is if you’re selling, but you can always trade ETFs at the Nav. And that’s like putting those into the machine or taking them out.

Mike:01:04:22Talk more about Nav, talk about the specific process. Because we agree we go through this all the time we run some ETFs and we see those hairy bars and we just start.

Rodrigo:01:04:35It’s like both relationships are good. It’s when you don’t control the relationship and they’re buying at the wrong time at a time close whatever, right. So, if you do own it that mechanism…

Mike:01:04:46Yeah, so Nancy walk through that maybe, just hypothetically not for any fund that any of us manage. The Nav Based Create process, because I think that’s tremendous value add.

Nancy:01:05:03So, let me share screen. So, all ETFs have a creation size. Let’s just look for first we’ll look at SPYDR just because it’s a big ETF. You can go to the you know it’s probably on the website or whatever but you could call your ETF desk and say, what’s the creation size. Most ETFs trade in 50,000 shares, that’s a kind of typical creation size in the US. What is it in Canada?

Mike:01:05:28It’s about the same.

Nancy:01:05:29About the same, so let’s see. Some ETF issuers charge a creation fee, like SPYDR charges $3,000. IVOL I made it small on purpose, I did the smallest we could at the time which was 25,000 shares. Because I want it to be efficient. I want it to be like a good thing for clients and then we waived the creation fee. So, it’s zero. This is about is 25,000 shares times the Nav of the fund is one creation unit. So, let’s just put in, you guys HRAA-CN, right. So, all yours has 25,000 share and yes also great for investors, no creation fee. I was hoping that was the case. So, both your ETF and my ETF are very efficient.

And here I’ll show you, we go to our presentation deck. This is not specific to IVOL, but if you go to the back of our presentation deck it is page, which one. This one, page 17. It has a little slide here, not specific to our fund all ETFs work this way. Describing primary market versus secondary market. Secondary market is the shares outstanding, it is the clothes and the laundry machine they just trade hands. Primary market is adding laundry or taking it out of the bin, and you can use that with the AP’s. Our fund we have 17 different AP’s and you can even do it with your custodian. You just call up and say, I’d like a Nav Based Create or you can ask for a Block Trade. And then you can compare to see which is better for your investors to use. But I think it’s awesome that you guys have no fee, because it just makes it more efficient.

I think it’s also good when you have dislocations in the market. Like for instance March, March was a mess in the US treasury market. The treasury market got completely whack and that’s my technical term for it. You know it broke; liquidity can go in any market at any point. If say you owned any treasury ETF, IVOL anything and you wanted to sell and the fund was trading at a discount to NAV. You could also sell using a NAV Based Regime. So, it’s just a good thing for you know ETF investors to know as fiduciaries. They can always decide, which is a better way to execute primary or secondary. It sometimes depends whether you’re buying or selling which is better.

Adam:01:08:00So, your counterparty on the options book. Are they’re willing to create redeem intraday give you or give the AP’s quotes on the underlying so you can stay at Nav there? You didn’t have any trouble in March with pricing those or create some redeems?

Nancy:01:08:22The fund that we use had a lot of problems, it was trading at a substantial discount to now.

Adam:01:08:25Yeah right.

Nancy:01:08:26Pretty much every treasury ETF dislocated, because the treasury market broke. So ETFs, the liquidity of ETFs is only what is the underlying. ETFs are often blamed for liquidity events, but ETFs are the only thing that trade. The reason that people were using ETFs to trade treasuries is they couldn’t trade treasuries directly in the market, because it was broken. So, most pretty much all treasury ETFs were trading at a discount to NAV and that’s just because the ETF was the only thing that was actually had liquidity.

Pricing ETFs

Adam:01:09:00I remember Andrew Miller pointing out in, I think it was March 19th or something that the TLT was trading at a 7% discount and a half. That was just really, that was scary.

Rodrigo:01:09:13 Now, with  IVOL, were you able to price it based on the underlying NAV of the Schwab or did you have to use the market of the ETF, well not the ETF, the Schwab product?

Nancy:01:09:29So, ETFs always have two prices. There’s the NAV and then there’s the secondary market, so it’s always the same. I have nothing to do with pricing. I don’t price, you know the administrator prices the book. It’s not the portfolio manager who does that. So, I’m sure the same with your ETFs. I have nothing to do with pricing, it’s independently priced. Which is a good thing for our investors.

Adam:01:09:51Yeah, I was wondering whether the options can be the AP’s have access to pricing and like they can go to the dealer and add exposure to those options intraday to facilitate creates or redeem exposure in those underlying options to facilitate redeems. And it sounds like they can, which is really neat.

Nancy:01:10:16Well, they do for the options piece. They deliver the treasury ETF in kind, so they deliver shares of the Schwab ETF and then they deliver cash and … for the options. So, it’s actually incredibly efficient, because our fund is a 14-billion-dollar treasury fund and then the AP delivers cash. So, we always change the basket every night because it’s actively managed and distribute that to all the ETF participants. But it’s a pretty efficient fund, because the create regime, I remember the fund was like a baby fund. It was like, I don’t know 20 million dollars and we had an Australian investor interested and they’re huge.

You know the Australians love, cheap fees and long convexity. I’m like I’m their girl right, and the Canadians. But we had a Canadian fund that was like how much liquidity can we get. I was asking different AP’s you know to give us markets and they were making 250 million NAV based trade markets. And IVOL when the whole fund was 20 million, but that’s because the underlying is a 14 and a half billion-dollar treasury fund in cash and …. So, it makes it super-efficient in terms of the create redeem process.

Mike:01:11:32Yeah, it’s an implicit versus explicit liquidity type scenario that I think, that’s why I wanted to go into the Creates. Because it is you know just because when you were in that gestation period and there wasn’t a lot of liquidity on the markets. The markets that you’re trading have you know not infinite liquidity but certainly massively significant liquidity and thus these are things that that are probably not well known generally. So, I do have one other question coming to like. So, on the convex book on the options book when you have a daily priced product, right. One of the things that I think that we’ve always known is something that’s hard is okay, so you get a convex payoff.

Then you have to think about money coming in and out on a daily basis and how to sort of manage the tail wagging the dog. I don’t know if you can delve into that at all. Is it proprietary or is it part of the sort of the gamma and big exposure that you’re managing on hold in the options book that you think about that? How do you manage that?

Nancy:01:12:46So, I operate as a fiduciary for the fund and I always do what is right for the fund as a fiduciary in my discretion as the portfolio manager. So, daily flows in or out of the fund, you know the nice thing is it’s not an index fund, right. We’re not trying, index fund is trying to replicate an index and not have tracking error, right.

Mike:01:13:05Price insensitive.

Nancy:01:13:06Yeah, the fund portfolio manager is judged entirely on, do you have tracking error and if so, how much. I do not have that problem. I operate as a fiduciary for the fund I don’t have to do anything ever unless I hit my risk limits. That the only time I ever have to trade is, if the fund was you know we had 20 option premium, I would have to take it down. But I don’t ever unless I’m hitting a risk limit, I don’t need to ever do anything that’s not in the shareholders interest. That’s a nice thing for our investors because there are a lot of equity VOL strategies that are passive and that’s fine if you’re selling options. Because you have to have you know you want them to expire you want them to go away. But if you’re long options if you have something move inter month, you don’t want to have to wait till the end of the month and hope that thing is still down.

Like a good example would be February 2018, right. That was when the Fed changed the CCAR calculation and the US and Canadian equity markets dropped like a rock on Friday and Monday. But if you only rolled at the end of the month with a passive fund, you were screwed because it all came back. It was just that like little bit of environment. So, if you’re going to own, if you have gamma if you’re long VOL and you are long convexity, I think it would be foolish to ever have a passive fund in my opinion. Did I get your question good?

Mike:01:14:37Yeah, of course. So, it’s about judgment it’s about you know you are acting in the best interest of the shareholders. And you know if you get a massive payoff, you’re going to have to think about that and your risk limits and make decisions within the context of that. I’m summarizing of course, and that’s the expertise and judgment that people are paying for when they buy IVOL or invest in any of the other Quadratic mandates that you’re operating. We would second that motion. Yes, we like that.

Rodrigo:01:15:12All right. Well, is there anything else that you gents haven’t covered for Nancy?

Mike:01:15:20No, I appreciate the time. Nancy is there anything else we haven’t covered? What are the top questions everybody else asked that we have not stumbled across?

Nancy:01:15:31You guys have been awesome. It’s been a lot of fun. I mean not what I normally do on a Friday evening. So, a pleasure to join you all and I hope you guys stay safe and keep cracking. I’ll watch your ETF; it looks awesome and you know really appreciate the time to be on your show. If anyone has questions about the fund, you can always go to our website. It’s ‘IVOL ETF’, you can email us. Ask questions and you know nice thing about ETFs is, it’s fully transparent. Like I love the product because it’s just such a great. And the one thing I would say is allocators need to really embrace the ETF technology. Because it’s a co-mingled fund right.

And having I guess my big thing is, I don’t think it makes sense if you have public securities, why would you stick them in a private fund wrapper. You know the only reason people do that is because it’s a manager compensation scheme. Because you can lock up their AUM and charge more. So, I think public security is being in a public fund wrapper just makes so much more sense. So, I’m fighting the fight I think ETFs are awesome. They’re great technology for investors and I hope you know hopefully you get some of the Canadian pensions to embrace it. Because they’re all allocators and they’re all allocating to these like you know blah blah blah esoteric hedge funds that don’t have liquidity. When you’re trading liquid public markets, why not have the liquidity and the transparency and the lower fees.

Adam:01:17:04There we go.

Rodrigo:01:17:05Amen to that.

Nancy:01:17:06Amen to that.

Mike:01:17:08Thank you for your time and I will remind everybody, because I thought this particular show was absolutely spellbinding. So, I will remind everyone to like and share ‘ReSolve Riffs’. And propagate the message so that we can continue to have great guests like Nancy on and continue to share, I think thoughtful and novel and unique angles and views on the ETF market, the futures market portfolio management optimizations and etc. So, smash the like button, share and give ReSolve and IVOL some love.

Adam:01:17:46Exactly. All right, thanks guys. Have a great weekend.

Nancy:01:17:51Thanks so much, really pleasure being your guest. Thank you.

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