If you are like me, you probably have a good friend or family member who has gone gluten-free in the last several years. A 2009 study published in Gastroenterology found that celiac disease has increased from one in 650 people to one in 120 over the past 50 years. Dr. Ciaran Kelly from Harvard’s Teaching Hospital has postulated that the rapid rise in celiac could be in part due to wheat being genetically modified to the point that it triggers an immune response.
What does this have to do with investing? Much like the food industry, the finance industry has a propensity to tinker with the “genetic” make-up of investment vehicles. Some of these changes have been positive. For example, in the food industry, there have been some seeds that have been modified to be drought resistant or increase the yield of the crops helping feed those in third world countries. Financially speaking, there have been "modified" products that have increased returns or helped reduce volatility. However, as you can imagine, sometimes the tinkering can have unintended consequences. When it comes to food this can lead to health and digestive issues. When it comes to investing this can lead to out of control volatility and extremely poor performance.
A good example of a "modified" investment product is something called the iPath S&P 500 VIX (ticker VXX) that was created to follow the S&P 500 Volatility Index. A simple explanation of the volatility index is that it tracks the amount of volatility the market expects there to be. When there is a negative surprise in economic news it will typically spike upwards. In principal, it seems like a good idea - if you could buy a security that goes up with bad news, it seems like it would be a great way to protect your portfolio. Here is a graph of its results over the last two years.
In blue is the actual S&P 500 Volatility Index. Over the last two years it has been almost flat at a -0.16% return; however, VXX (in red) lost 72.14% during that same time period. What sounds like a good idea quickly became a nightmare for almost any investor that has held on to it for even a short period of time. Because of the way VXX is constructed, it will never actually replicate the index and will always have negative returns over any significant period of time.
What can we learn from this? Just like a healthy diet avoids genetically modified foods, a healthy portfolio avoids exotic investment instruments. Much like your caring for your body, you should be careful about what you put into your portfolio. As the financial industry develops, new investment vehicles will continually reach the marketplace. While not all of them will be bad, they're probably not as great in reality as they're advertised to be and it is always healthy to bring a reasonable amount of skepticism before adding any of them to your portfolio. Gluten-free investing? Perhaps not, but sometimes the basic investments are the healthiest.