Downside Of Short ETFs
Yesterday I mentioned one way to size short ETF positions to hedge a portfolio. So if you can do just as well without putting up as much cash, why would anyone not go for these things all the time? Well, there’s a lot that goes on behind the scenes with these guys. Short ETFs just attempt to match the daily move of the underlying index by fudging their positions on a daily basis. Since it’s an ETF that’s very actively managed, there are a lot of fees that go along with it.
Also, since it’s just matching the daily movements of the index, over the long run that doesn’t quite work out due to compounding. Say you started both funds at $100, one which is a double short of the other. If the index goes up 1%, the double short goes down 2%. After the first day, the index would be $101 and the ETF would be $98. If the same thing happened a second day, the index would be $102.01 and the ETF would be $96.04. Now let’s say the index goes back to $100 on a 1.97% drop; the ETF would go up 3.94% and end up at $99.82. That’s minor right now, but over the long run it will end up not tracking the index as tightly as you may be hoping for.
While not a disaster, it helps to understand why the S&P500 may go down 30% but SDS only goes up 50%. Ideally, if you truly want two times the short exposure to an index, you would play the index futures or options so that you can manage your long term exposure a little more finely, but of course those have a whole other can of worms that go along with them. Your 401k probably doesn’t have that option though, so knock yourself out with the short ETFs and watch your portfolio at least stay afloat while everyone else is eating it.
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