Distressing Details of the UltraShorts 62 comments
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Over the last month, a number of commentators have begun to vociferously denounce levered ETFs, pointing out that, over periods of time longer than a day, many of these ETFs don’t deliver what you’d expect them to.
The first that I am aware of was Eric Oberg at TheStreet.com, who argued against ProShares Short ETFs in two pieces: “Why Short Sector ETFs Aren’t So Smart”, TheStreet.com, December 23, 2008 and “The Perils of the ProShares UltraShorts”, January 13, 2009.
In those pieces, Oberg detailed how the ProShares UltraShort Real Estate ETF (SRS) actually fell 48.2% from Jan 2, 2008 through Dec 17, 2008 even though the index it is supposed to deliver double the inverse return of fell 39.2%! In other words, if you shorted real estate via this ETF last year you would have lost 50% of your money! Disgusting.
The same thing happened with the ProShares UltraShort Financial ETF (SKF) which returned 1.4% over the above period when the underlying index fell 49.3%. So much for double short! Terrible.
Ditto for the ProShares UltraShort FTSE/Xinhua China 25 ETF (FXP) which Dr. Doom Marc Faber recommended in Barron’s in 2008 as a way to short China. The long China ETF, iShares FTSE/Xinhua 25 Index (FXI), was down 46.7% in 2008 and the UltraShort ETF was down 57.2%! Brutal.
Yesterday, in a comprehensive piece “Warning: Leveraged and Inverse ETFs Kill Portfolios”, Paul Justice of Morningstar hammered home the point.
The ProShares UltraShort MSCI Emerging Market ETF (EEV) actually fell 25% last year even though the underlying index was down 52%!
The ProShares UltraShort Oil & Gas ETF (DUG) actually lost 19% last year when the Dow Jones Oil & Gas index was down around 40%.
The whole thing makes me sick. Obviously, many of these ProShares UltraShort ETFs don’t work over periods of time longer than a day, making them unsuitable to implement a longer term investment thesis.
One question is whether it’s just the ProShares UltraShort ETFs that are disasters. Looking at Oberg and Justices’s examples, the ProShares double levered long ETFs seem to have done a pretty good job: URE (Ultra Real Estate), UYG (Ultra Financials) and DIG (Ultra Oil & Gas) delivered about twice the return of their respective indexes in 2008. SSO (Ultra S&P 500) also appears to have done a good job.
One of the main reasons these ETFs fail is that they are designed to deliver double the return of the underlying index on a daily basis. This daily compounding leads to distortions over longer periods of time, especially when the underlying indexes are especially volatile. Oberg points out that the ProShares Ultra and UltraShort S&P 500 ETFs have done a pretty good job because volatility in the S&P 500 isn’t that great compared to some of the sectors like emerging markets, real estate and financials.
As someone who does some trades using these ETFs, this is a big worry for me. I’ve been studying the charts, and the ETFs I’ve been trading lately (SSO, DIG, TBT) seem to have done a good job of delivering what I was hoping they would. But it’s raised some real doubts for me about the suitability of these investments. It’s worth realizing that these ETFs do what they do by owning derivatives and so it’s not a perfectly transparent implementation. I’m still thinking about whether or not I want to be involved with these vehicles. I’ll be watching them closely.
Disclosure: Top Gun owns SSO, DIG and TBT.
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This article has 62 comments:
I'll now consider buying puts on IYR next time I look to short RE.
Total return = intraday + interday variation
These derivitive-based funds seem to only capture the intraday portion. If an investment typically declines interday but typically rises a smaller amount intraday, the double-short ETFs will not work.
Also, derivitive prices are based on investor judgement and guesswork, while indices are based on markets.
Now if the ETF was holding options a few months or years out, the value of those options should be correctly reflected long-term. We'll have to examine our prospecti closely to determine what technique is being used.
On Jan 23 03:59 PM Clare123456 wrote:
> Please comment on USO performance long term.Does it suffer from the
> same malais?
On Jan 23 04:18 PM market ace wrote:
> USO is a commodities trading partnership and is not = to a barrel
> of oil like a gold ETF. I have had terrible results with this in
> the past and when you get a K-1 showing commodity trading gains or
> losses totally unrelated to the stock price it is not a pleasant
> shock. So far the new UCO seems to be doing amuch better job of tracking
> real oil prices.
Slippage is a very old topic on these boards.
1.) enter only with strong conviction/research market sector/index is weak, and 2.) always employ a stop-loss (I use the 5% rule), and just as importantly - 3.) take gains off the table when it's chart goes parabolic - that means EVEN if the market fundamentals still support declines in the underlying sector/index.
I've had major troubles with the UltraShorts when I disobey rule #2
It had a very good performance. Now i hold DXO (ultra-long on OIL), and it does not have the same performance of the OIL. The OIL this week was up from 35 to 44 and the DXO finish the week with the same price at the begining
I watch each ones current volatility because it changes lots. I only invest if it's got lots of volatility. The up/down +10 per day (DOW drops 200), or +1 per day (DOWN drops 200) changes lots over time per symbol.
One example:
EEV almost got me! I put lots of money into EEV because it moved so much, then it's voltility just disappeared. I sold with only $100.00 gain, but got out. I also have questions concerning how that $100.00 gets taxed or does it get taxed etc...etc..
I am holding TBT for a long position though. TBT is almost a sure bet against the 20 year Treasuries!! When money flows out of treasuries and back into bonds or the market, interest rates will surely rise. If we are lucky enough to get some major inflation with all the trillions being printed - the big lotto jackpot could be at the end of the TBT rainbow!!
There is nothing more frustrating than realizing your investment thesis was correct while watching your investment vehicle do the opposite of what it should.
Excellent question!!
How do we know the accounting is straight in these "ETFs"? Answer - we don't.
How do we know there is not a flaw in their methodology? Answer - we don't.
How do we know the people running these things are honest? Answer - we don't.
At this stage of the game, after Madoff, Cox, Thain, Cayne, Fuld, and assorted other crooks and scamsters have raped the market and/or the companies they worked for - what can you trust?
An ETF? Really? I mean, REALLY??
On Jan 23 03:59 PM Clare123456 wrote:
> Please comment on USO performance long term.Does it suffer from the
> same malais?
On Jan 23 06:01 PM Thomas J. Gordon wrote:
> Do people think there is a psychological component to these ultra
> shorts or are they only priced according to the value of the assets
> they hold? srs is an etf. It sits on the market and people can
> trade it. Those days in november when it went over 200 there were
> lots of people who thought the reits were done for and that they'd
> never borrow another dollar in the credit markets. Is that why it
> went over 200 and quickly fell back?
At the end of the day it all depends on being a share that is bought and sold, by the time you buy it everyone who's smart is selling it. You need to be counter cyclical in these plays. If we could all just buy an ultra short EFT when the market was going down we would all be rich and retired!
I sold them in January, just under 3mo later, when they were way down and I couldn't stand it any longer, even though the plan was to keep them until the market really tanked later in the year.
Afterwords, I thought I would check out how well they had tracked their indexes. The Nasdaq 100 was down less than 1% so I should have been up about 2%. Instead I was down over 18%. The Russell 2000 was down 2.4% so I should have been up about 5%. Instead I was down 33%. And the S&P 500 was up 3.6%, so I should have been down about 7%. Instead I was down 33% again.
My total loss was about 28% of my investment: about $8600.
I have barely a decent size retirement, which I will be ok with, but only if I stop blowing money like this.
I suspect there are many others out there who have, are right now, or who will be, burned by these "investments." I speak from a prejudiced point of view, obviously, but I think it is unconscionable for these instruments to be sold without making it obvious to the buyers what they really are. Based on what I am reading, this is not what the companies that are pushing these products are doing.
But then again, maybe I shouldn't expect that at all. After the scummy revelations we have all seen of what the financial industry really seems to be, perhaps I am just naive and need to grow up.
Well, I just got a nice bee sting and I hope I have learned my lesson. But ya know, investing is risky, and its bad enough as it is without having to worry about getting ripped off by some scumbag's greedy financial engineering wet dream. But on the other hand, there are a lot of folks who have been stung far worse than I have, so I'll quit whining.
Tomorrow is another day.
I got it.
On Jan 23 03:48 PM Jeff332 wrote:
> They're trading vehicles and you'll see that they perform pretty
> well over short periods of time. Longer term, all bets are off.
> If you want leverage and are going to hold for a long time, then
> go with options.
Of course, there's probably some really simple reason why this can't be done (because otherwise it seems like the most obvious trade one could make). Does anyone know the feasibility of this, or any flaws in the reasonings given above?
The key to these Ultra ETFs is DAILY performance. Would it therefore seem that they all eventually go to single digits? (e.g. DXO, UYG....)
If an ultrashort ETF is truly operating on a daily basis, whenever there is a gap down from one day's closing to the next day's opening, you are "robbed" because you "miss" the overnight drop. Gapping is much more likely in high volatility markets. But remember, the opposite can also occur, especially in a falling but tranquil market: The next day's opening can be higher than the previous day's close, so that you "double up" on that part of the previous day's drop that is retraced before the tumble continues.
If the ETF does not increase the shares available as demand increases, then there is a premium included in the price, which is caused by demand in excess of supply. And vice-versa for a discount to price.
I still love the ultra ETFs and ETNs, because, unlike options, there is no premium paid for time (rather, some of them actually pay a dividend), and if you hold for over a year you get LTCG rather than STCG tax treatment. It's very important to know the underlying structure of the ETF. For example, for DIG it is simply oil and gas and drilling and refining companies (go to marketwatch.com, search for DIG, then hit profile and you see the exact list), so DIG is going to track its index very well.. For DXO and DAG, it is all futures contracts, where contango and backwardation have huge influences. These ETFs are about as alike as apples and cats.
1) First, I agree that because of the reasons widely cited, we cannot trust the leveraged SHORT ETFs beyond a short time frame. However, how well can we count on Proshares double long ETFs (such as UYG and URE) to track their indices? The general agreement seems to be that they track them well.
2) Now, if ultralongs such as the Proshares UYG, URE and DIG track their underlying indices better over the longer term, as well, as implied over the SHORT term as it is also generally agreed, wouldn't it be smarter to short the Ultralongs instead? Why should this be done, or why should it not be done?
3) The market is trending downwards, although we are in a bear market rally, so can we trust these leveraged LONG funds (1X 2X 3X) to provide the same accurate tracking when the market is finally turned around and heading UPWARD? Or will the same market forces (or agents) that keep these SHORT funds from tracking their indices well lately prevent them from tracking well--and thereby keep them from performing well for investors--when the market is trending upwards? There seems to be a built-in handicap that is directional that will always work against the investor.
4) Also, is anyone tracking the Direxxion 3X ETFs for their performance. I suspect the Direxxion 3X Ultrashort funds (FAZ, ERY) are performing like the much-criticized SKF and SRS, and delivering poor returns beyond a very short time frame. But what about the 3x longs such as FAS and ERZ? Possible to short them instead of purchasing shares of FAZ and ERY?
They are not buy and hold unless of course you adjust your position on a regular basis. I use the SH (Short S&P 500) more than the double, I like the fact that you can get short and not use margin. It truly did a great job in my 401k....
* 1 month +8% vs -2.9%
* 3 months -19% vs 0%
* 6 months +42% vs -30%
* 1 year +51% vs. -38%
3 months SDS performance was terrible.
1, 6, and 12 months performances were good but nowhere near double-reverse of S&P500
Long-term investing is futile in the present environment. Everybody from the Treasury, the FED and financial institutions are against retail investors. The entire financial system is very corrupt and terribly dishonest.
Unless, Obama administration and the Congress cleanup the entire system, it will collapse together with US economy.
Since I do not expect much, if any, from our corrupt and incompetent politicians. Consequently, the present reserve-currency system will go down crushing. I see gold as only one of few alternatives.
On Jan 23 03:59 PM Clare123456 wrote:
> Please comment on USO performance long term.Does it suffer from the
> same malais?
On Jan 23 04:27 PM 69fasty wrote:
> What about Ultra Long ETFs? Are they also questionable over long
> periods of time?
Starting from the beginning of 2008 and accounting also for the distributions, as of today SDS has delivered a gain of 79.1% against a SPY loss of 41.3% (SH +48.4% in the same period). Quite consistent!
Even TBT, in the same period, has lost 36% of its value against a TLT gain of 17.2%.
Maybe it's really the volatility to blame for the abysmal performance of the other DoubleShorts, but we can't say we had no volatility in the broad equity market. Actually we saw an all time record there this last year.
Could we say that's just depending on the managers' skill?
On Jan 23 08:18 PM genesok wrote:
> I believe anyone doing the least bit of investigation into the leveraged
> etfs would understand the advantages and disadvantages of using them.
> Your headline "Distressing Details of the UltraShorts" seems to me
> to be inflamitory and disparging of a very useful product. There
> was nothing distressing for me using these products the last year
> (they saved my ass), along with regular equities, giving me an annual
> return ofover 50% for 2008. There has been numerous articles on this
> site explaning how they work and anyone using them should have not
> only read, but thought about the information on how the calculations
> are make. All readilly available at the fund's sites!
www.synergeticstocks.c...
then go long using the bullish tech scans:
www.synergeticstocks.c...
This article sheds ABSOLUTELY NOTHING new on a topic that has been beaten to death. Most people don't understand these products. I've seen 2 or 3 really SOLID ideas laid out here, but no one wants to think beyond the obvious.
On Jan 25 10:54 AM wadaman7 wrote:
> There's something fishy here. I recently saw both USO and DUG rise
> simultaneously!
In the vein of 'distress', may I suggest doing an article that addresses the K-1 nightmares. That will also be a good topic for the people who may not know what to look for in a prospectus/SAI, such as the 'limited partnership', PTP and so forth. The real issue with K-1 producing ETFs is that even if you lose money in a transaction, you may still be slapped with a phantom income, for which you owe taxes. That does not make sense at all. So, I am taking the approach to avoid all funds that produce K-1 at the tax time. Any thoughts?
On Jan 24 09:35 AM DaveW wrote:
> What has not been mentioned yet here is how the Ultras and UltraShorts
> are built differently. The Ultra ETFs are long their respective
> underlying index, and are fairly accurate in doing so. The UltraShorts
> do not directly short the underlying index via equity shorts but
> by options and swaps which are held as short-term contracts which
> decay over time, then must be renewed via new contracts...repeat.
> Thus, they are POOR tools and must be used carefully via the short-term
> only.
news.morningstar.com/a...
On Jan 23 05:48 PM marketman54 wrote:
> I am holding TBT for a long position though. TBT is almost a sure
> bet against the 20 year Treasuries!! When money flows out of treasuries
> and back into bonds or the market, interest rates will surely rise.
> If we are lucky enough to get some major inflation with all the trillions
> being printed - the big lotto jackpot could be at the end of the
> TBT rainbow!!