Profit And Peril, Double Short ETFs Offer Both
When exchange traded products first burst onto the investment scene with the debut of the SPDR S&P 500 Trust (NYSE: SPY) back in 1993, the primary mission of this asset class was to offer investors a lower-cost alternative to mutual funds, not to expose investors to the types of risks offered by double short ETFs.
Back then, the intent of ETFs was not to become short-term trading vehicles used by professional traders, but rather to become destinations where cost-conscious investors could park some cash at a better price than what the comparable mutual fund would offer.
Times change and the ETF business has evolved in a major way. While most pundits would agree the rapid evolution of the ETF industry has been good for investors, critics argue that the surging popularity of double short ETFs, or double leveraged inverse ETFs exposes investors to myriad risks they are not capable or knowledgeable enough to deal with.
Advocates of double and triple short ETFs would argue these perhaps the best tools for investors to establish bearish positions on sectors or indexes without the lofty margin requirements of directly shorting stocks or the time constraints of being long put options. With that, let’s examine the controversy surrounding “CEF Connect” and double short ETFs.
Double Short ETFs: Know What You’re Getting Involved With
The controversy behind double short ETFs, or ETFs designed to deliver 200% of the daily inverse performance of a particular index, stems from two primary sources. First, most double short ETFs used a combination of swaps, options and other derivatives instruments to accomplish their objectives. Since these funds are constantly buying new contracts, they usually have much higher expense ratios than traditional ETFs.
Second, there are myriad examples of double short ETFs not delivering their intended performance over long-term holding periods. One popular example is the ProShares UltraShort Financials (NYSE: SKF), a double short ETF that allows investors to establish a bearish trade on an index that tracks major bank stocks such as Bank of America (NYSE: BAC) and Citigroup (NYSE: C). Due to the expenses associated with holding double short ETFs for extended time frames, SKF actually performed worse than many of the major U.S. banks during the financial crisis, leading to criticism of leveraged and inverse ETFs at large.
Double Short ETFs: A Date, Not A Marriage
Still, criticism of double short ETFs is not warranted because ETF issuers make very clear on their Web sites and in the prospectuses for the funds that these are DAILY instruments. That means double short ETFs will due what they’re supposed in a single day or over a few days, but they are not long-term investments. Investors that turn double short ETFs from a date to a marriage will find themselves looking for a divorce sooner rather than later.