Cramer Is Right about Ultrashort ETFs

 |  Includes: SKF, SRS
by: TraderMark

I've been doing a lot of reading lately on the construction of the ProShares instruments and frankly have to agree with the criticism. We bought Ultrashort Financials (NYSEARCA:SKF) and Ultrashort Real Estate (NYSEARCA:SRS) back in August 2007. Despite the carnage of a lifetime, Ultrashort Financial has only appreciated from $90 to $120 in almost a year and a half - that's ridiculous. Ultrashort Real Estate is down by almost 50% from where I first bought it in August 2007! This is despite the underlying instruments it is shorting against falling by 30-80% in many cases. That's insult to injury - not only would you not have made money, you lost money if you "bought and hold".

So we nailed both of these theses yet have benefited very little. It is becoming very apparent that due to the rebalancing (daily) in these instruments, they are useless for almost anyone other than daytraders or people who hold them for 1-5 days. They are constructed poorly. Someone holding SRS or SKF should have been able to buy it in August 2007, go on a 15 month vacation to Tahiti, and be up 50-100%+ at this time. Instead you are down severely on one and up way below potential on the other? What's the point?

We are sort of stuck because I cannot short individual names in, so all I have are the short ETFs to provide downside exposure. (people trading in tax protected accounts, i.e. rollover IRAs - have the exact same issue since shorting is not allowed) They work great on the days the market falls off a cliff, but each day the market goes sideways, they basically act like an option - you get time decay. It is so much like an option you need it not only go in the right direction but in a set amount of time; that's terrible for a long term hedge.

It would be far superior to short against the index these instruments are betting against so that you can actually benefit over the long run. I'm not sure if the non "Ultra" (2x) instruments work the same way (the 1xs) - this is something I have to look at during the next week. With how poorly these 2x ETFs work, if the 1x ETFs (non Ultra) don't have the same weaknesses, for purposes of someone like me who uses them as a hedge and wants to hold them for more than 5 days, they might be a better choice.

On top of all that, they are like a mutual fund and today declared distributions... cripes.

  • ProFunds Group, the world’s largest manager of short and leveraged funds,1 has announced fourth quarter income dividend distribution declarations for its ProShares ETFs. The firm expects dividend distributions for 52 of its 76 ETFs. Capital gain distributions for 35 of the firm’s ETFs were announced earlier today.
  • Distributions reduce the net assets of each of the affected ETFs as of the close of business today and the ETFs will trade ex-dividend tomorrow. Each portfolio’s exposure to its benchmark index will be adjusted today to reflect this reduction in assets.

I will give Mr Cramer kudos on this one; aside from adding to the extraordinary volatility in markets (8 of the 10 most traded "stocks" in the past month have been these lousy ETFs as institutions use them as gambling chips), they are constructed so poorly that even if you are correct on a thesis, you still lose. That's pathetic.

Disclosure: Long Ultrashort Real Estate, Financials in fund; no personal position