These are trusts holding U.S. Treasury securities designed to track three times the movement of the Case-Schiller Composite-10 Housing Price Index. The pair is a closed system; when the index moves 1%, 3% of the assets in one trust are moved to the other trust. This move defines a change in the net asset value of each trust, one up -- UMM -- and the other -- DMM -- down.
Investors have not become acquainted with how these new investment trusts work. When they do, I think they will become very popular. Now, while they are not well followed, there may be frequent inefficiencies that will lead to great trading opportunities for people trading volumes less than a few percent of the average daily trading volumes. I, for one, am going to be looking for small position opportunities here.
Let's expand this with a specific hypothetical example. If the current net asset values of the two trusts were both $25, and the Composite-10 decreases by 1%, 3% of UMM (75 cents) transfers from that trust to DMM. The resulting NAVs change to $25.75 for DMM and $24.25 for UMM.
The trading prices of the two trusts are determined by market traders. If the resulting market prices are $25.50 for DMM (vs. NAV of $25.75) and $24.60 for UMM (vs. $24.25 NAV), this implies a market opinion that house prices (indicated by the Composite-10) will be increased from today's level at the trust termination date, which for the current trusts is August 2014.
An increase in house prices by the termination date is implied when market prices are higher than NAV for UMM and lower for DMM. Invert these relationships, and lower termination date house prices are inferred. There are two things to note:
- Although the NAVs are exactly balanced so that the total of the two will always equal $50, the two market prices can deviate unequally from NAV values due to trading action. This gives arbitrage opportunity, although only for small fry. The daily trading volumes averaging around 15,000 - 20,000 shares daily (for each trust) are way too small for professionals.
- The deviation of market price from NAV can be used to calculate an inferred Composite-10 Index value at termination (currently five years from now).
Macro Markets publishes a weekly bulletin reviewing market action for the two trusts. They currently calculate an inferred index value for August 2014 of 160.33 compared to 151.00 ($151,000 Composite-10 average house price) as of the latest index report. This reflects the market assessment, as of Friday's market close, of the likely average price of homes in the Composite-10 markets ($161,330) in August 2014. The latest Case-Schiller Index contains data for May and was announced at the end of July.
The Macro Markets inferred average price for August 2014 would constitute a 6.18% cumulative gain from the May 2009 index or approximately 1.42% compounded annually. If prices were to fall an additional 10% in the next year or so, as some are predicting, achieving $161,330 by August, 2014 would constitute an annual price increase of 2-3% from a bottom occurring between one and two years from now. That would be close to long-term historical averages before the recent bubble.
For those considering investing in UMM and DMM, a graph from Macro Markets provides valuable insight.
The leverage of UMM is evident here with the comparison to the ETF for homebuilders, the
. From July 13 through Aug. 7, XHB rose approximately 30%, and UMM shot up about 80%. Also, one might expect UMM and XHB to show strong correlation, but over the past week, UMM is down and XHB is up.
That divergence ended Monday, Aug. 10, as both declined. UMM was down 1.22% to close at $23.85 and XHB dropped 3.35% to close at $15. These moves basically reversed the correlation divergence experienced last week. Entering an arbitrage opportunity with UMM and XHB at the end of last week could have paid off today for the alert individual investor.
John B. Lounsbury is a financial planner and investment adviser, providing comprehensive financial planning and investment advisory services to a select group of families on a fee-only basis. He worked for 34 years with IBM, and spent 25 years in R&D management and corporate staff positions. He also was a Series 6, 7, 63 licensed representative with a major insurance company brokerage for nine years.
Specific interests include political and economic history and investment strategy analysis. He holds degrees from the University of Vermont, Columbia University and the Illinois Institute of Technology, where he studied chemistry, physics and mathematics. He is a contributor to Seeking Alpha and his own blog,