Despite my constant warnings of conditions favoring a credit event (which clearly hasn’t happened in corporate credit yet), I’ve made it very clear that shorting and inverse trading just does not work. You can be bearish by lowering your beta exposure or by being in Treasuries for a moment in time as opposed to by making an outright directional bet against stocks, and frankly, that tends to work way better over time.
Having said that, there are plenty of people who disagree, which is why I want to focus on the ProShares Short S&P500 ETF (NYSEARCA:SH). Managed by ProShares, this unique ETF offers inverse (-1x) exposure to the daily performance of the S&P 500. This means that if the S&P 500 index declines, the value of the fund should increase, and vice versa.
Launched on June 19, 2006, SH has an expense ratio of 0.89% and net assets of nearly $2 billion. It is important to note that this fund is not suitable for all investors due to its inherent risks, including the use of derivatives, imperfect benchmark correlation, leverage, and market price variance.
Understanding the ETF’s Holdings
SH achieves its net short position primarily through the use of swap contracts. These contracts are agreements with various banks that act as counterparties in a futures contract on the S&P 500. If the S&P 500 index increases, the fund pays the daily return to the counterparties from its cash holdings, causing the value of the fund to decrease. Conversely, if the index declines, the banks pay the fund, thus increasing its value.
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Sector Composition and Weightings
The ProShares Short S&P500 ETF does not directly invest in individual companies. Instead, it uses financial derivatives to replicate the inverse performance of the S&P 500 index, which comprises companies across various sectors. The information technology sector had the highest weightage in the index, followed by healthcare, financials, consumer discretionary, and communication services.
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Peer Comparison
When compared with other similar ETFs, the ProShares Short S&P500 ETF holds a unique position due to its inverse exposure to the S&P 500. Most other ETFs are designed to track the performance of the index rather than provide an inverse return, and those that are inverse tend to focus on multiples/leveraged tracking. There are other unlevered inverse ETFs in the market, such as the AdvisorShares Ranger Equity Bear ETF (HDGE), which shorts individual stocks directly, resulting in higher costs. Both have done poorly given large-cap movement this year.
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Pros and Cons of Trading SH
Trading the ProShares Short S&P500 ETF comes with its own set of advantages and drawbacks. On the positive side, SH can act as a hedge against market declines, potentially generating profits when the S&P 500 index falls. Furthermore, it can be used to underweight exposure to a market segment.
On the flip side, SH is subject to the risks associated with derivative contracts, including price, credit, and interest rate risks. Moreover, because of its inverse relation with the S&P 500, the fund can suffer losses when the index rises. It’s also worth noting that SH is designed for daily trading and may not provide the desired returns over a longer holding period due to the compounding of daily returns.
To Trade or Not to Trade
If you anticipate a significant market downturn and are comfortable with the risks associated with inverse ETFs, SH can help you get to where you want to go. I just don’t like products like this broadly, making this a strong avoid for me.
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