All Article Categories
ETF Portfolios
ETF Provider Press Releases
ETF Thoughts
Investing
List of ETFs
I've thought about the idea of an inverse exchange traded fund (ETF) on occasion. The idea is that this ETF would move inversely to some index so that when the ETF would go up when the index goes down.
Something about this idea bothered me, but until today I didn't know what it was. Sure an inverse ETF could probably be constructed, but what would it be good for? The idea behind a diversified portfolio is to assemble holdings that are uncorrelated, but trend upward in the long-run. The uncorrelated feature is key as it is what reduces volatility. And the long-term upward trend is also key since you want your portfolio, in its entirety, to grow over time.
An inverse ETF on the other hand would simple move in the opposite direction of an index. So if you held equal amounts of an index ETF and an inverse ETF for that index, you would presumably make no money whatsoever. Seems kind of pointless, doesn't it?
So I finally get to toss the inverse ETF idea. I'm glad I didn't find a way to waste money on such a product.
Entries (RSS)
November 5th, 2006 at 3:22 pm
Inverse ETFs are very useful tools for finance professionals, particularly on the buy side firms, who have severe restrictions on their personal trading imposed by their firms. Most commonly they could include (like in my case) (a) a minimum holding period of 90 days (b) NO short-selling.
Now suppose for example, you happen to invest in an index ETF and 10 days later you realized that the top has happened. You can't get out due to personal trading restrictions. What could you do ? You need to hold that ETF for another 90-10=80 days and you can't take a fresh short position either.
September 19th, 2006 at 7:12 pm
While it's true that simply negating another investment is counter-productive, this is not the role of shorting.
Often, portfolios are almost fully invested and deciding to pull the plug and sell may trigger large capital gains.
A short in a specific sector may take the edge off the risk of a larger composite index.
For example, The Canadian index (S&P/TSX) contains large portions of energy and mining stocks as well as financials. If an investor decides that the energy portion of the index is getting to risky he can short an energy position to offset some of that risk, while keeping the overall composite index.
Thus, if the index had been held for a few years, holding on to it does not trigger a massive taxable capital gain.
Any shortfall attributable to the energy sector would be somewhat offset by the rise of the energy shorts. As a bonus, should the investor be long term bullish on energy, the extra earnings on the shorts could be reinvested at a lower buying price.
So, short ETFs are decent tools to offset sectors that appear to be weakening, without having to resort to a wholesale cashing out of a portfolio. It thus gives some extra breathing room in cash and time to decide one's long term asset allocation, especially when the direction of the markets seem uncertain.