As of last Tuesday there is a way to trade houses just like you would stocks – sort of. A company called MacroMarkets has created two instruments that allow people to take positions that bet on the price of houses going up or down in 10 markets that comprise the Case Shiller 10 City Composite Index. The motivation for creating these instruments (aside from MacroMarkets collecting fees) was to permit homeowners to hedge their exposure to housing prices. These instruments are similar to ETFs in that they trade on the exchanges and their value is (loosely) tied to an index value, that being the 10 City Composite Index. The way MacroMarkets created these instruments is that they deposited money into two trusts – one of which represents an interest in the underlying index going up and the other representing an interest in the underlying index going down. Under the terms of the trusts, assets are passed back and forth between the trusts based upon whether the index goes up or down – i.e. when the index moves up money is transferred from the down trust to the up trust. Macromarkets then issued shares in each of the trusts – the MacroShares Major Metro Housing Up shares trade under the symbol UMM and the MacroShares Major Metro Housing Down shares trade under DMM.
Unfortunately, nothing in this life is simple. The devil is in the details. First you need to understand what comprises the Case Shiller 10 City Composite Index. It’s a weighted sum of the index for 10 cities as follows:
|› Las Vegas:||0.01480245|
|› Los Angeles:||0.21161961|
|› New York:||0.27239040|
|› San Diego:||0.05513356|
|› San Francisco:||0.11787881|
|› Washington, DC:||0.07849949|
As you can see it’s largely influenced by New York City, Los Angeles, and San Francisco – not exactly representative of the nation as a whole. Second, the trusts fluctuate in value based upon 3X the percentage change in the index – i.e. if the index moves up 1% the up trust benefits by 3%. Third, the benefit or detriment to the trusts is based upon the cumulative percentage change from the Starting Level of the index, which was somewhat arbitrarily set on February 24, 2009 when the index was 162.17. This level of the index corresponds to both the up shares and down shares having an underlying value of $25 each. Since the most recent index value was 150.34 the underlying value of the up shares is now $19.53. Fourth, the trusts terminate on November 25, 2014 when a payout is made to the shareholders based upon the underlying value of the trusts at that time. Consequently, the up and down shares will trade based upon investors’ expectations of the index value on the termination date – i.e. they will trade at a discount or a premium to the underlying value today. What that means is that in order for you to profit from these securities the index will have to move by more than what the market expected on the day you purchased them and it will have to move in a favorable direction. For example, if you buy the up shares the Case Shiller index will have to move up by more than what was implied in the price on the day you bought the shares. More on this later.
But wait, there’s more! The trusts can terminate early for any of 13 different reasons, including if the index drops below 108.11 or if the amount on deposit in the up or down trusts falls below $10 MM (someone at MacroMarkets explained that it is really based upon the combined value of the two trusts being below $20MM). Well, an index level of 108.11 corresponds to a further 28% decline in the index, which would put it back at June 2000 levels. So maybe that’s not that likely to happen. However, the trusts currently have only $20.5 MM on deposit between the two of them and there are two ways that it can fall further. One is through the redemption process, which is one of the mechanisms that is used to keep the two classes of shares priced reasonably (the other mechanism is the creation process which would increase the assets). The other way the value can fall is through a gradual erosion of value from the very high fee structure, which is 1.25% of assets plus $600,000 per year for each trust. Well, with only $20.5 MM on deposit this thing is on the hairy edge of termination. The last investment vehicle that MacroMarkets created like this, the up and down oil shares, recently died a similar death. And before it died the shares lost about 1% in value per month just due to expense erosion.
So what if the trusts terminate early? Well then, instead of your time horizon being November 2014, it suddenly shrinks to a much closer timeframe. While you might expect the index to move higher by 2014 you might not be as confident of that occurring in the next 3 months. So your entire investment thesis gets discombobulated.
If you can deal with all these nuances there might be a play in here for you. At the very least we might get some insight on what the price of these instruments tells us about expectations for the future. As of today the last trade for the up shares occurred at $14.00, which implies an index value of 135.6 at termination – another 10% drop from current levels. Only thing is we can’t really tell if that is a forecast for November 2014 or a forecast for an early termination before then.