Markets

Are Inverse Funds Worth Your Money?

By Larry Swedroe

Updated on: October 12, 2010 / 11:09 AM EDT / MoneyWatch

My colleague Kevin Grogan at Buckingham Asset Management was recently asked about leveraged inverse ETFs. I thought what he found was especially valuable for those thinking about using these funds as hedges.

Specifically, Kevin was asked about the ProShares UltraShort S&P 500 ETF and whether including the ETF in his portfolio would effectively hedge against a declining market. The ProShares UltraShort S&P 500 ETF seeks returns of twice the inverse of the daily performance of the S&P 500 Index.

Kevin looked at the question a couple of different ways. First, he compared the year-by-year return of the ETF versus the yearly return investors may think they would get by investing in the ETF:

	SDS	S&P 500	Twice the Inverse of S&P 500	Difference Between SDS and Twice the Inverse of the S&P 500
2007	-3.65	5.49	-10.99	7.34
2008	61.36	-37.00	73.99	12.64
2009	-50.60	26.46	-52.93	2.33

As you can see, the fund doesn't quite get you twice the inverse of the S&P 500 when you look at it on an annual basis. To ProShares' credit, its Web site says that its performance should be evaluated based on daily performance, not long-term performance. From the ProShares Web site: "In a volatile market, compounding can result in longer-term returns that are less than the sum of the individual daily returns." Unfortunately, many investors invest in ProShares products for a strategic long-term allocation, not as a day-to-day tactical bet. Two other reasons for the underperformance are likely the higher expense ratio (0.91 percent) and the cost of margin.

Next, Kevin simply compared SDS's the performance numbers since inception (August 2006) against the S&P 500.

	Annualized Return	Annualized Standard Deviation
ProShares UltraShort S&P 500 ETF	-9.91	33.95
S&P 500 Index	-2.59	18.78

As you can see, both the S&P 500 and the ProShares UltraShort S&P 500 ETF have had negative returns since inception. In fact, the ProShares ETF is down further than the S&P 500. Purchasing this fund at inception would not have provided the desired hedge.

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