Over two years before Credit Suisse's VelocityShares Daily Inverse VIX Short-Term Exchange-Traded Note (NASDAQ:XIV) lost 95% of its value this February, the Securities & Exchange Commission warned about the complexity of exchange-traded notes (ETNs) in a December 2015 Investor Bulletin.
As an example of this complexity, specifically as it pertains to XIV, consider the product name ("XIV"), which is a clever reverse spelling of the index it is inversely tied to ("VIX"). We've barely escaped the mere title of the ETN, and have already encountered a confusing name with great opportunity for inadvertently transposing the two similar abbreviations/symbols.
Cautioning (in bold and italics text), "You should understand that ETNs are complex and involve many risks for interested investors, and can result in the loss of your entire investment," the SEC explained that as unsecured debt obligations tied to the performance of a reference index or benchmark, ETNs in general are most often not held to maturity, and, as complex products, are subject to credit risk such as issuer default, market risk, price volatility, leverage/inverse complication, and risk of liquidity.
In XIV's case, multiple risk factors combined to cause catastrophe.
First, XIV was subject to daily fluctuations opposite of, or inversely tied to, the volatility index known as CBOE's VIX.
Second, as stated in the preceding sentence, an ETN directly linked to the performance of an index with "volatility" in the title is, inherently, subject to volatility risk.
Third, XIV was designated a short-term ETN, meaning XIV was categorically unsuitable for investors with an investment horizons or outlooks longer than a single day. Credit Suisse's prospectus advised investors not to purchase the XIV ETN if seeking an investment with a "longer duration than a daily basis."
Fourth, the this product was specifically designed only for sophisticated investors. The Credit Suisse prospectus, warns not to invest if "you are not a sophisticated investor."
Fifth, XIV's termination risk (including issuer default and liquidity risk) was realized when Credit Suisse announced plans to liquidate the XIV ETN when the CBOE Volatility Index (VIX) spiked in early February, causing XIV to fall dramatically.
The 2015 SEC advisory asked investors and brokers alike to consider whether ETNs are a suitable recommendation, given an investor's investment objectives and risk tolerance. For instance, the XIV ETN was specifically marked in the prospectus as unsuitable for investors who were risk averse or who preferred lower risk strategies, and similarly unsuitable for investors who sought long-term investments and/or current income from the investment.
If you have invested with a broker or financial adviser in Credit Suisse's VelocityShares Daily Inverse VIX Short-Term Exchange-Traded Note (XIV) and this complex ETN product was unsuitably marketed to you without adequate risk disclosure and without regard to your conservative or moderate risk tolerance level and/or your investment horizon and objectives, and this unsuitable recommendation to purchase XIV has proven harmful to your investments or interests, please call The Law Offices of Jonathan W. Evans & Associates at (800) 699-1881 for an investigation and consultation.