Inverse ETF’s are designed to rise when the market falls and fall when the market rises. They often use daily futures contracts as a way of betting on the direction of the market they represent. A futures contract is an instrument used to buy or sell a security at a set price at a certain time in the future. There is no guarantee that an inverse ETF will match the long-term performance of the index or stocks it is tracking. It is just the fund manager’s best attempt at doing so.
If the market falls, the inverse ETF will rise by roughly the same percentage minus fees and commissions from the broker. There are leveraged ETF’s that multiply the returns (or losses) of the underlying securities or index. Normally an ETF’s price rises or falls on a one-to-one basis compared to the index it tracks. A leveraged ETF is designed to return 2 or 3 times the movement of the index. Inverse ETFs can lead to losses quickly if the investor is wrong on the direction of the market.
There are inverse ETF’s for many of the common indexes as well as the different sectors and industries. Some investors use inverse ETFs to hedge their portfolios against declining prices.
Inverse ETFs are not long-term investments since the underlying futures contracts are bought and sold daily. This frequent trading often increases the management fees and other costs of owning an inverse ETF.
There are advantages to owning an inverse ETF to shorting a stock or index.
• Inverse ETFs do not require the investor to hold a margin account whereas short selling does.
• It is usually less costly than short selling, which requires a stock loan fee paid to the broker.
• Stocks with high short interest may result in difficulty finding shares to be short. This may drive up the cost.
• It is easier for an investor to take a position in an inverse ETF than it is to sell stocks short.
To further evaluate inverse exchange traded funds go to ETFdb.com where you will find an up to date list and description for these funds.