Shorting ETFs for the Long Run?

Includes: PST, TBT
by: IndexUniverse

By Murray Coleman

In case you missed it, juiced-up inverse bond ETFs are here. Could this really turn out to be a more workable solution for long-term investors to hedge their portfolios?

As Matt Hougan recently noted in his excellent review of the ProShares UltraShort 20+ Year Treasury ETF (NYSE: TBT) and several similar rivals, fixed income seems to provide much less tracking error during periods of market fluctuations than its leveraged and inverse equities rivals. (See article here.)

That begs the question, could bonds turn out to be a safer, or more mild-mannered and logical, way for investors to add some hedging strategies to long-term portfolios?

“In the vast majority of circumstances measured over a day, a week or even a month, these types of funds will likely deliver close to a simple multiple of the long-term index return,” notes Hougan in the article.

But he adds: “As you extend out over a month, however, more care is needed. Investors looking for long-term negative exposure must periodically monitor their exposure to the index, and adjust their positions if the discrepancy becomes too large.”

That raises the question of whether a longer-term investor might be able to put tighter asset allocation bands around such funds. For example, could a fairly conservative investor permanently allocate 2-3% to the ProShares UltraShort 7-10 Year Treasury ETF (NYSE: PST) and rebalance anytime it moves within 0.50-1.00 percentage points either way?

Matt points out that the relatively tame nature of bonds makes them less likely to show huge deviations from stock futures and/or markets as we’ve seen in many leveraged ETFs sporting 200% and 300% exposures.

Perhaps only someone with an iron stomach could figure out whether this would work over longer periods. But what about if someday enough leveraged bond ETFs were out there to create a sort of market-neutral hedging portfolio?

Just a thought … probably not worth much. But as a lot of the mainstream media jumps on leverage and inverse ETFs, such criticism could prove premature. The market is young and immature … I’m in the camp that more choices are better for investors. It’ll be interesting to see how this marketplace grows and matures.

Along those lines, did you see that a new company is proposing to offer some very interesting inverse ETFs that would play different types of bonds and stocks against one another? The return differences between two indexes—such as corporates and Treasuries—would get 200% inverse exposure. (See story here.)

Personally, I wouldn’t touch leveraged and inverse stock ETFs with a 10-foot pole. But I’ve seen enough over the years to realize there are some investors who are experienced in these areas and might be able to use them to their advantage.

For some brave souls, mixing and matching this growing assortment of leveraged and inverse index-based portfolios might turn out to be a plausible way to gain cheap access to sophisticated hedging strategies.

To each his own …

By the way, if you haven’t heard, Matt (along with Jim Wiandt) was named the other day to an industry analyst’s ETF Hall of Fame. As Dave Nadig remarked, are you guys doing autographs now?

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