The Potential Benefits from MacroShares

In November 2006, Claymore Securities and MacroMarkets LLC (a firm co-founded by Robert Shiller, of Yale and "irrational exuberance fame") issued the first so-called MacrosShare ETFs. MacroMarkets and Shiller have long been focused on finding ways to make it easier for investors to hedge and speculate on macroeconomic risk factors. The new MacroShares were one result of this process, while exchange traded futures and options that track U.S. housing price indices were another.

The first issue of MacroShares were focused on oil price risk, as measured by the price of oil futures contracts traded on the New York Mercantile Exchange (NYMEX). Conceptually, the design of the oil MacroShares is elegant. They are issued as a matched pair of ETFs, with equal values when they were initially created. Cash received by Claymore when the ETFs were issued was invested in a portfolio of short-term Treasury securities. When the oil futures price index rises, the so-called "down" oil MacroShare (ticker DCR) makes a payment to the so-called "up" MacroShare (ticker UCR), and vice versa. As these transactions evolve over time, the net asset values of the two oil MacroShares will also evolve.

Unfortunately, UCR and DCR got off to a bit of a rocky start, with actual market prices trading at a premium (in the case of the up share) and discount (in the case of the down share) to their respective NAVs. Rumors had it that this was caused by uneven order flow and some initial issues related to market maker support to offset these market pressures. Whatever the the cause of these initial problems, they seem to be shrinking as the market gets more familiar with this new type of instrument. All of this is interesting, but begs the more important question: does either of these MacroShare ETFs belong in an investor's portfolio?

For a preliminary answer to this question, we revisted our previous analysis of oil ETFs, and created a data series that tracked the reverse of the change in price of Brent crude oil (granted, this isn't exactly the same as the NYMEX futures price, but it is close enough for our purposed here). We used this series as a proxy for the real return on the down oil MacroShare between the first quarter of 1989 and the last quarter of 2004. The correlations between the real return on "down oil" and the real returns on other asset classes are as follows:

The results are pretty much what you would expect. When oil prices fall, it is good news for equities and commercial property, and generally bad news for investors who are long commodities and equity market volatility. The opposite would be the case for investors in the "up" oil MacroShare. Nowhere in this analysis, however, do we see a compelling case for treating oil MacroShares as a separate asset class. Rather, the "up" share is best seen as a way of tilting one's commodity exposure more towards oil (which, as you can see in the table above, you could also do by switching from a fund that tracks the Dow Jones AIG Commodity Index to one that tracks the more energy oriented Goldman Sachs Commodities Index). As for the "down" share, there are better ways - like equities - to profit from a fall in the price of oil.

However, none of this should be interpreted as a criticism of the MacroShares concept. Rather, we just wish that MacroShares had been issued that track asset classes that are more useful from a portfolio management perspective. Like what? We have two suggestions: equity market volatility and the real change in U.S. Gross Domestic Product. Both of these would provide valuable hedging benefits to many retail investors' portfolios. Consider the following table, which shows the correlation of the quarterly real returns on different asset classea with the real return on U.S. equity market volatility, as measured by the VIX index (think of it as the "up" volatility MacroShare) and the inverse of the change in U.S. real GDP, as measured by the U.S. Commerce Department's Bureau of Economic Affairs (think of it as the "down" GDP MacroShare):

Both of these potential MacroShares look like they would be much more attractive candidates for inclusion in a broadly diversified asset class portfolio than the oil shares that are already on the market. Of course, another challenge would be finding enough investor interest on the other side of these MacroShares - that is, finding investors who would want to be short equity volatility (i.e., owning shares that would go up in value when the VIX falls) and long real GDP. The first probably wouldn't present much of a problem, as there is substantial anecdotal evidence that quite a few hedge funds are already boosting their returns by going short volatility. Finding parties to go long GDP might be more of a challenge, as some may believe there are better ways to do that (e.g., by being long domestic or global equity). However, with the use of leverage, we suspect that the returns on the up GDP MacroShare might be made sufficiently attractive to attract sufficient attention from the hedge fund world.

In sum, in spite of the initial teething pains that have been experienced since their launch, the concept of MacroShares holds great promise for opening up access for retail investors to a range of new asset classes that could provide substantial new diversification benefits to their portfolios. We look forward to the continued expansion of this product line.

| This Month's Issue: Key Points | This Month's Letters to the Editor: FT Articles: Commodity Index Funds' Future Contract Rollovers and VIX and Barclays' Water iShare | Global Asset Class Returns | Asset Class Valuation Update | Implementing Withdrawal and Savings Strategies | The Potential Benefits from MacroShares | Style Rotation With REITS | Product and Strategy Notes: Recent Research Reports and STILL more ETF Products | 2006-2007 Benchmark Portfolios - All Currencies |