Inverse ETF

Inverse ETFs give ordinary investors the ability to express a bearish view on an index or sector without needing a margin account to sell short. When the underlying benchmark falls 1%, the inverse ETF is designed to rise 1% on that same day. ProShares offers some of the most widely used inverse ETFs in the U.S. market, including the ProShares Short S&P 500 (SH), which provides -1x exposure to the daily performance of the S&P 500.

Like leveraged ETFs, inverse ETFs use derivatives including swaps and futures contracts to achieve their daily inverse exposure. And like leveraged ETFs, they reset their positions each day, which creates the same volatility decay problem over multi-day holding periods. An investor who holds SH for a month during a sideways, choppy market may find the fund has lost value even if the S&P 500 ended the month flat, because the daily reset compounds losses asymmetrically.

Inverse ETFs serve several legitimate short-term purposes. Portfolio managers may use them as temporary hedges during periods of elevated downside risk — for example, ahead of a major macroeconomic event such as a Federal Reserve meeting or an earnings season when broad market volatility is expected. Rather than liquidating equity positions and incurring taxes, the manager buys an inverse ETF to offset near-term downside exposure.

Some inverse ETFs are also leveraged, combining the two characteristics. The ProShares UltraShort S&P 500 (SDS) delivers -2x the daily return of the S&P 500. These products amplify both the profit potential and the loss potential, and the volatility decay problem is correspondingly worse.

Financial advisors and regulators consistently warn that inverse ETFs are short-term tactical instruments, not long-term portfolio holdings. Holding an inverse ETF as a hedge for months or years virtually guarantees return degradation relative to a simple short position, due to the daily compounding of errors.