The Night Effect: Analyzing the New NightShares ETFs

What is the "Night Effect"

Most equity trades take place during the day when markets are open. That being said, equities can and do move after hours, and are capable of sizable moves during this time. In today's globally interconnected capital markets, participants are digesting information and acting on it 24/7. 

The theory is that if equities do move after market hours in a statistically significant way, then isolating this factor, called the Night Effect, could help capture unique sources of risk and return. This is no different to isolating traditional equity factors like size, value, investment, or profitability. 

When it came to formulating its investment thesis, NightShares relied on the following studies:

• “Return Differences between Trading and Non-trading Hours: Like Night and Day” Michael Cliff (Virginia Tech), Michael J Cooper (University of Utah), Huseyin Gulen (Purdue University), September 26 2008.
• “The Stock Market Works by Day, but It Loves the Night”, New York Times, February 2, 2018.
• “Night Trading: Lower Risk but Higher Returns?”, Marie-Eve Lachance (San Diego State University), July 18, 2015.
• “Bad Days and Good Nights: A Re-examination of Non-Traded and Traded Period Returns”, Robert G. Tompkins (Frankfurt School of Finance and Management) and Zvi Wiener (Hebrew University of Jerusalem), March 4, 2008.
• “On Overnight Return Premiums of International Stock Markets”, Mei Qui and Tao Cai (Massey University/New Zealand).
• “Overnight returns of stock indexes: Evidence from ETFs and futures”, Qingful Liu (Fudan University/China) and Yiuman Tse (University of Missouri), January 9, 2017.

A simple way to observe this phenomenon in real-time is by holding a notable mega-cap stock like Apple (APPL) through a pre-market or after-market earnings report. Depending on the news, the stock can experience a substantial move many magnitudes greater than its intra-day movement. Because many of Apple's peers also report earnings around a similar period, their after-hour movements can cause indexes to move accordingly. 

Breaking down the ETFs

NightShares notes that trying to capture the Night Effect by buying equities after hours and selling them before the next trading day is prohibitively expensive in terms of transaction costs. 

Hence, the firm opted to use the ETF structure, which allows them to package derivatives like equity index futures and swaps into a liquid, transparent, and investor-friendly instrument. The expense ratios range from 0.55% - 0.67%, which is fairly reasonable for a complex structured product. 

Let's take a close look at NSPY. As of January 2nd, 2023, the majority of the holdings in NSPY (48.63% to be precise) are held in March 2023 S&P 500 E-mini futures. 

The remainder of NSPY is held in an assortment of assets used as collateral for the E-minis, which include U.S. Treasury bills, various Bondbloxx Treasury ETFs, sweep vehicles, and interesting enough, USDF, a bank-issued stablecoin offered by various FDIC-backed institutions. 

NIWM is constructed in a similar way, with the exception of March Russell 2000 E-mini futures to provide it with small-cap exposure. The interesting one is NSPL, which also includes a 32.37% allocation to the iShares Core S&P 500 ETF (IVV) in addition to the usual 47.18% allocation to March 2023 S&P 500 E-mini futures.

The combination of IVV plus S&P 500 E-minis intended to give NSPL 1x leverage to the performance of the S&P 500 during the day, but 1.5x at night. This is a fairly interesting and novel use of futures I haven't seen before with other ETFs, and a clever way to lever up without using swaps. 

NightShares ETFs: Final thoughts 

To sum it up – the NightShares ETFs are highly innovative, but also fairly complex. I think they can be a suitable wildcard bet for investors looking for a new way to outperform the index. It's definitely a niche investment thesis that until now, hasn’t been readily accessible to retail. 

Personally, I look at it the same way I view other equity factors like small-cap value. You're taking an educated risk for the potential to outperform an index, but it could also backfire and cause you to lag it for a substantial period of time (as evidenced by how large-cap growth dominated over the last decade). 

Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.