Williamstown, MA, August 30, 2008 --(PR.com
)-- The latest edition of ETF Momentum Tracker (http://www.fidelityadviser.com/readMe_ETF.asp) examines the phenomenon of short ETFs, taking a closer look and the risks—and rewards—associated with the new range of “short bets” flooding the marketplace.
For years, short selling has been largely a strategy for high-end investors—through hedge-fund or separate-account management—and sophisticated advisors. Now, thanks to ProShares, these strategies are available to everyone.
First introduced in 2006, these ProShares short ETFs are designed to go up when their indexes that underlie the benchmarks go down (and vice versa). The goal? An investment vehicle that comes with all the ease and low expenses of ETFs and that can be used by savvy investors to seek profit in a market downturn or to hedge an investment.
“As we’ve seen in recent months, the stock market can be a tough place to play,” notes Don Dion, publisher of Fidelity Independent Adviser’s ETF Momentum Tracker (http://store.fidelityindependentadviser.com/etf1yr.html), “sooner or later, every sector, every country, and every region takes its lumps.” Among the wide range of mutual-fund categories tracked by Morningstar, no domestic or international stock categories are in the black for 2008. The S&P 500, the Dow Jones Industrial, and the NASDAQ Composite are all off between 10% and 14%, while the MSCI EAFE (Europe, Australia, and Far East) is down 20.7% year to date and nearly 17% in the last three months (through Aug. 22).
This week’s edition of ETF Momentum Tracker (http://store.fidelityindependentadviser.com/etf1yr.html)offers Dion’s profile of the ProShares Short MSCI EAFE (EFZ), which promises the inverse of the well-known global index. EFZ has delivered on its promise, posting a year-to-date gain of 22% and a three-month jump of 20.45%, both among the top 20% in Morningstar’s Bear Market category.
EFZ’s index aims to include 85% of the free float-adjusted market cap for each major industry group in developed markets, excluding the U.S. and Canada. Launched on Oct. 23, 2007, EFZ uses derivative contracts called swaps to get the inverse return of the MSCI EAFE.
“Essentially, swaps are contractual agreements for an exchange of returns between two financial institutions,” Dion said, “so, to bet against the index, the fund enters a swap agreement with a counterparty—usually an investment bank or hedge fund—that agrees to pay it 1% for every 1% the MSCI EAFE falls.”
Swaps made up the overwhelming majority of assets in the EFZ portfolio, according to proshares.com, but the fund could use any number of complicated derivative instruments, such as exchange-listed futures, options on futures contracts, forward agreements, and listed options on individual securities. Assets not currently invested in derivatives or securities are frequently invested in short-term debt and/or money market instruments.
“Few investors know a lot about such vehicles,” Dion asserts, “but given current market conditions, these inverse funds have enjoyed increasing popularity.” In June, ProShares celebrated its second birthday with an announcement that assets have grown to $20 billion. (Recently, EFZ held about $26 million.)
“ETFs such as EFZ, paired with long-oriented strategies, can enhance returns by lowering the portfolio’s correlation with broader markets,” Dion adds, “done correctly, such a strategy can reduce the overall risk of the portfolio and deliver higher risk-adjusted returns.” During the 2001-2002 downturn, the typical bear fund rose 20%, while diversified stock funds fell almost 16%, according to Morningstar.
Despite the potential upside, Dion believes that these ETFs may burn investors in the long run: “the majority of bear funds tend to hibernate during bull markets,” Dion said, “the category suffered an average loss of 7.7% annually over the last five years, according to Morningstar—and some losses have been potentially devastating.”
Should investors consider short ETFs, like EFZ, appropriate for their portfolios? Dion believes that there is a time and a place: “EFZ and its ilk have a role in a portfolio,” Dion concludes, “but most investors should remember the risk involved and keep their allocation small.”
ETF Momentum Tracker is a member of Fidelity Independent Adviser’s family of financial publications. With more than 70,000 subscribers in the United States and 29 other countries, Fidelity Independent Adviser publishes four monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers. http://store.fidelityadviser.com/pws1yr.html
Don Dion, publisher of Fidelity Independent Adviser, is also president and founder of Dion Money Management, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Massachusetts, Dion Money Management manages more than $750 million in assets for clients in 49 states and 11 countries. A licensed attorney in Massachusetts and Maine, Mr. Dion has more than 25 years’ experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management. http://www.dionmm.com/