Leveraged and inverse ETFs are a relatively small but growing portion of the overall business. These specialized funds that magnify market returns and profit from market declines are designed for traders rather than buy-and-hold investors.
“Successfully betting on market downturns is very difficult, and even the most intrepid investors find it difficult to consistently execute an effective shorting strategy. Stock prices tend to rise over time, so shorting should be done only tactically and for a short period of time, if at all,” says Morningstar analyst Timothy Strauts in a primer on inverse ETFs that let investors short the market.
Short ETFs can be used to bet on market downturns or to hedge.
“The simplest and easiest way to get short exposure is to buy an inverse ETF. There are currently 244 leveraged and inverse products with $28.8 billion in assets,” Strauts wrote.
The biggest leveraged inverse ETF is ProShares UltraShort S&P 500 (NYSEArca: SDS). It seeks 200% of the opposite return of the S&P 500, after fees and taxes. [Bear ETFs: Leveraged Funds That Short the S&P 500]
ProShares Short S&P 500 (NYSEArca: SH) is an unleveraged ETF that shorts the market.
“These products have been popular with investors because the ETF provider handles the complexities of managing the short exposure. Also, unlike other shorting methods, leveraged and inverse ETFs can be purchased in many tax-sheltered accounts,” the Morningstar analyst said. “The upside to this downside exposure is that, when buying an inverse ETF, you cannot lose more than your initial investment. Conversely, shorting a security has theoretically unlimited potential losses.”
Strauts cautions that inverse ETFs aren’t designed as long-term holdings.
“Because of the compounding arithmetic of constantly resetting the exposure to negative 100% of the daily return, investors are not guaranteed to get the index’s inverse return for any holding period longer than one day. To counteract the effects of daily leverage reset, inverse ETFs need to be rebalanced regularly,” he said. “Managing an inverse ETF is definitely not a set it and forget it transaction.”
Short ETFs have been pushed lower recently on the stock rally.
ProShares Short S&P 500
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