Drawbacks of Double-Short ETFs

Late Sunday a reader left a question about this article which first ran on RealMoney and then was re-run on some sort of page at Fidelity’s web site.

It is written by Eric Oberg and like several pieces he has written for RM it is an in depth dissection of the drawbacks of double short ETFs.

The big story is the day to day compounding that can either make holders very happy or make them regret ever buying shares. In the above link he cites an example of iShares Financial (IYF) being up 8% over some multi-month period while the ProShares Ultra Short Financials (SKF) being down 69%. BTW I am not questioning the math at all.

My only involvement with SKF, or any double short sector fund, was a couple of articles for RM a few years ago spelling out a potential pair trade. The concept I put forth generally “worked” for a while but obviously would have unraveled as we got deeper into the crisis. The only portfolio action I ever took with any double short fund was with the double short S&P 500 (SDS). It did not perfectly track twice the inverse of the SPX but it generally went up over time as the market went down, on days where the market was down a lot it pretty much did what it was supposed to and I was quite happy with the result and the volatility dampening effect on the portfolio.

There are a couple of things I would point out in defense of these products. Clearly, anyone who thinks these funds have collectively malfunctioned has a point. While the objective is for the daily result the example above of plus 8% versus down 69% would be very disappointing, no argument. It is true though that in the same time period, longer really, everything (perhaps a little hyperbole) has malfunctioned one way or another. The spastic movement in equity prices, volatility, commodity prices, currencies, muni yields compared to treasuries and a half a dozen other things perhaps make this a less than ideal time to draw a conclusion.

I would note that in the year ended March 9, 2009 SDS was up 80% while the S&P 500 was down 50%. Obviously not exact (actually if you add the dividends it gets closer to 100%) but of course that is not the objective. Had I held it all the way through to March 9 I would have been thrilled with the result. The reason I stopped at March 9 is because the rally since then has knocked the stuffing out of SDS. The daily reset that occurs will be rough if the market goes up every day for such a long stretch.

Given that the funds worked “better,” not perfectly, before things got so out of hand I believe it is possible that these funds will work better when things normalize and if they never do normalize then maybe the sector products should never be used. My willingness to use SDS in the future has not been hampered by this in the least.

About Roger Nusbaum 169 Articles

Roger Nusbaum is an Arizona-based financial advisor who builds and manages client portfolios using a mix of individual stocks and ETFs. Roger writes a popular blog, which focuses on risk management, foreign stocks, exchange traded funds, options etc.

Roger has been recognized by many in the investment management industry for his expertise in portfolio management. Roger has been regularly interviewed by the financial press, trade journals, and television news shows. He has also had numerous technical articles published and has been quoted in a number of professional trade journals, newspapers, and consumer finance magazines. He appears frequently on CNBC Asia as a market commentator.

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