Naturally since there is something new coming, Dan Culloton is quoted with a negative opinion. That same article also noted the following.
Take the Nasdaq 100 between June 11, 2002, and March 17, 2003, a time that covered the end of the bear market and the first part of a rally. During that time, the Nasdaq 100 lost 2.19%. So if you were in UltraBear Profund (Nasdaq:URPIX - News), a traditional mutual fund that tracks the inverse of the Nasdaq 100 by 200%, you might have expected to be up 4.38%. But no, you actually would have lost 33.22%, thanks to the strange arithmetic of leverage.
OK, well URPIX is leveraged to capture twice the inverse of the S&P 500 not the Nasdaq.
While expenses prevent it from capturing exactly double, the fund appears to be generally doing its job shorter term. Over the last 12 months URPIX is down 10% while the SPX is up 5%.
The general idea of this type of product is to make short-term bets on the market. To have a shot of success the fund needs to do what it is supposed to do and I would say that URPIX fits the bill for short periods of time. Longer term though the SPX is flat and URPIX is down 25% which seems odd.
I called the fund to try to get an explanation. The goal is to double the inverse. Over periods of time there can be a compounding effect that causes the fund to deviate from the goal. Also periods of extreme volatility (like the time period chosen by the author) increase the possibility of the fund's tracking error growing.
I did not try to pin this person down on whether the ETFs might have the same issues or not. This leaves us with a type of product that has flaws (like all products). Londoner asked if I would use the inverse ETFs. The short answer is probably. They provide a way to tactically reduce net long exposure for brief periods of time. I do plan to study them further once they start trading.
10 comments:
I know that Beta ProFunds here in Canada (don't know if they're related to ProFunds) has a similar product and the prospectus reads that the goal is a DAILY doubling of the change rate.
So I don't know if this has something to do with the tracking error (25% seems unusually large), but the daily issue would probably account for SOME of the tracking error.
Jay Walker
The Confused Capitalist
Thanks for the comments Roger - hope I didn't mislead you; there are leveraged ETFs listed in Paris offering upside exposure on CAC40 or FTSE Eurofirst (take a look at www.sgametf.com for interest - sorry, don't know how to turn that into a link...) but not yet with leveraged inverse exposure. You beat us to it on that one!
It seems like the tracking error has the ability to compound. Not defending the fund but just making the observation
I just hope they track better than the oil ETF-USO is a major disappointment. I can't understand why some of the hedge fund hotshots aren't arbitraging the big gap, so I contacted the management company and they said they couldn't comment as they were still in registration!
Yo Roger,
Whats up? Nice blog. Are the underlying positions of the inverse ETF actual short positions in each of the stocks? Or is the fund made up of a single short position in the respective index ETF instrument? (in this case the
Thanks
i have not read the prospectus. I hope they use either futures and/or put options. That would be much cheaper than than shorting individual names.
I learned the hard way that these leveraged funds (profunds/rydex) are definitely not buy and hold instruments.
Taken as a whole, I don't see how these funds are suitable for the vast majority of investors.
If you want less market exposure, sell your core broadmarket ETF, or shift from a index fund to a money market fund. Why hedge when you can sell?
"The reasons for this are complex, but in using futures contracts and other financial instruments, there are periods when cash can build up, money can be lost rolling contracts, and the fund has to be able to pay the fee of 1.43%."
I think this is how it works.
Think what would happen if a $10 index went to $15. At the inverse, you would lose 50% or $5. If the index went back down 50% or $7.50, you would only make back $2.50, or 50% of your $5. So you would have been right--the market declined 25% from your initial position, but you lost 25% due to the basic arithmetic of the inverse fund. It is a little complicated, but it has nothing to do with slippage.
Right, this "negative compounding" is counterintuitive, and a bear (pardon the pun) to understand, but can't be avoided the way these inverse funds are calculated. To avoid this long-term problem, they would have to change the short-term behavior, which traders wouldn't like.
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