What are Inverse Exchange Traded Funds (ETFs)?
- October 20, 2008 by Fox | Comments: 10
I’m a bit of a fan of exchange traded funds (ETFs) and have been a keen investor in them for years. So when a reader emailed me asking about investing in inverse ETFs during a bear market my interest was piqued.
Since the market has gone bonkers, or argumentatively into a bear or recession position, some fund companies have touted these inverse ETF products to get investors thinking about market opportunities. Could inverse ETFs be the solution to protecting one’s portfolio in a bear market and help one profit from market down swings? Or are inverse ETFs just a bunch of marketing muckity muck hype?
Let’s consider the following: what are inverse ETFs, why would one invest inversely in the market, and should you invest in inverse ETFs?
What are Inverse ETFs?
Inverse ETFs are a type of investment which sells like a stock or conventional exchange traded fund. Unlike conventional ETFs which move with an index, inverse ETFs track the reverse, or opposite, of the market.
Inverse ETFs are also called Short ETFs or Bear ETFs since they “short” the market to make money when the market goes down and provide a way for an investor to make money in a falling “bear” market. For example, an inverse ETF tracking the S&P 500 will do the opposite of that index. If the S&P 500 goes down 3 percent, the fund will increase by 3 percent. If the index goes up 3 percent, the inverse ETF will go down 3 percent.
Some inverse ETFs work at a multiplier greater than 1X. For example, if an inverse ETF works at a 2X multiplier, then the ETF moves twice the opposite of where the market moves.
Inverse ETFs can invest in broad market indexes, such as the NASDAQ or Russel 2000. They can also be bought to focus on specific sectors, such as financial, energy (oil), or consumer staples. Investors who purchase inverse ETFs do so to “hedge” their portfolios against falling prices.
To learn more about regular ETFs:
Reasons to Invest in Inverse ETFs (PROS)
Here are some positive aspects of inverse ETFs:
- If the market falls, you win! Profit from a decline in the value of an underlying benchmark. Who doesn’t like to make money when the market falls?
- Go short without a margin account. Since inverse ETFs are traded just as normal ETFs, they allow an investor to go “short” to some extent in any trading account. So you don’t need to have a margin account to take advantage of short positions. Although, if you’re savvy enough to want to go short in a market, you probably should be able to get a margin account anyways.
- Hedge investments. Many investors look to purchase inverse ETFs to hedge their portfolios against falling prices.
Reasons to Avoid Inverse ETFs (CONS)
Here are some negative aspects of inverse ETFs:
- If the market rises, you lose! When a bear market turns upwards, then you lose moolah.
- Betting against the market. Over the long term, history has proven the market trends upwards. So inverse ETFs are going against strong historical market data.
- Requires market “timing”. Inverse ETFs need to be purchased at the top and sold near the bottom to be profitable, especially since over the longer term markets trend upwards. Are you clairvoyant? Can you predict the bottom accurately enough? Think again!
- Expensive. Shorting stocks to do the reverse of an index requires more active work for the fund manager than passively tracking an index. Because of extra active management, inverse ETFs have higher management expense ratios (MERs) than standard ETFs. These little fees consume profits and principle if you’re not mindful of the true overall investing costs.
- Cannot “set it an forget it”. Since the market trends upwards, you cannot buy and hold inverse ETFs. You need to monitor and micromanage your portfolio.
- Newer and unproven. Conventional ETF funds have been around for decades. Inverse ETFs have not. How do these funds perform under a variety of market conditions and how do they fit into a good balanced portfolio? What are the tax implications? These are things to consider.
- Shorting restrictions. Recent market issues have caused regulators to introduce restrictions on shorting certain stocks. Will these restrictions be expanded? What effect will this have on the performance of inverse ETFs? (source)
- Complex investments. Reading about shorting, hedging, and the calculations that go into inverse ETFs is mind boggling. I strongly believe an investor should understand what s/he is invested in before plunking good money into a fund. If you don’t “get it”, then don’t buy into it. Yes, buyer beware.
Where to Find and Buy Inverse ETFs
Here is a list of some companies selling inverse ETF funds for both American and Canadian markets.
American Markets
ProShares: fund information
- ProShares Short Dow 30
- ProShares Short S&P 500
- ProShares Short Nasdaq 100
- ProShares Short Russell 2000
Rydex Investments: fund information
- Rydex Inverse 2x Russel 2000
- Rydex Inverse 2x S&P 500
Direxion Funds: fund information
- S&P 500 Bear 2.5x Fund
- NASDAQ 100 Bear 2.5x Fund
- Small Cap Bear 2.5x Fund
Canadian Markets
Horizons BetaPro ETFs: fund information
- HBP S&P/TSX 60 Bear Plus ETF
- HBP S&P/TSX Capped Energy Bear Plus ETF
- HBP S&P/TSX Capped Financials Bear Plus ETF
What the Experts Say!
Here are some technical sources and expert insights on Inverse ETFs.
- A Closer Look at ProShares Inverse ETFs | Seeking Alpha
- Shorting the Market with Inverse ETFs | The Motley Fool
- ProShares Ultra Inverse ETFs | The Big Picture
- Inverse and Leveraged ETFs | Canadian Business
- List of Inverse ETFs (Short ETFs/Bear ETFs) | Trader Mike
Your Turn!
Got any experience with investing in inverse ETFs? Got an opinion? Feeling bearish? Would you invest in inverse ETFs? Do share and comment!
If you enjoyed this article and would like to receive more, enter your email address in the box below. Daily articles from Squawkfox.com will be sent to your email inbox for free. We respect your privacy. Your email will not be shared. You can unsubscribe at any time.
Blog Reactions:
- This and That # 115: Easing Credit Crunch Edition October 23rd, 2008
Comments:
Inverse ETF’s are very interesting, however dangerous IMO, because you’re working with “leverage”
Wait, that’s how we got into this whole economy credit crisis!!
Maybe PUT options will be a safer short method
Shorting is not for the average Joe’s
Well any day I learn something new is a good day
Thanks for the lesson!
Not for me, as monitoring would cause me stress, but
still interesting to learn about
Inverse ETF’s don’t normally require the ETF manager to short actual stocks…They normally buy swaps with another investment house…Therefore, shorting bans don’t affect these ETF’s.
Puts are also another viable ‘option’. Can be used on many ETF’s or a broad universe of stocks.
DH
It is interesting to know we have all these alternatives. G
Well, I knew you’d come through.
Definitely good reading but this ain’t for me.
If I gave up my job and if I spent my days tracking my portfolio and if I had the smarts and bank account of Warren Buffett then maybe I’d consider it.
I think I’ll try it - NOT!
Thanks for the insightful article.
@Peter So happy to have helped.
I too am not interested in this kind of fund. It was interesting and fun though learning about another investment option. I’ll stick to my simple ETFs and “couch potato” style portfolio for now. I love your questions, so feel free to ask. 
Marci and Peter-
You don’t have to stress yourself monitoring these accounts. There are money managers that specialize in ETFs and Inverse ETFs that will do the work for you, obviously at a fee, but well worth it. Maybe something to give a try with a small portion of your portfolio for 12 months, then decide, get out or put more in.
Every time i come here I am not dissapointed, nice post