This is a guest blog from Jeremy Kwong-Law, CEO of BetterWealth - ETF portfolio building tool to help you create and manage your ETF portfolio.
In the 3 months to 29 Feb 2016, the Australian and global stock market has struggled. The ASX is down -7.3% and the US market is down -8.1%. If you think it’s impossible to make money in a downmarket using ETFs - think again!
Inverse ETFs provides a path to make profits when the market is falling. They are an alternative product to exotic and more risky products like CFDs and derivatives.
An Inverse ETF is generally an actively managed ETF. They are designed to profit when the market goes down, and lose value when markets go up. This reverse relationship is why they are called “inverse”.
Like all ETFs, you can buy / sell units on the ASX. Within the ETF / Fund, the manager will use your money to invest in a combination of cash products and sell Futures (i.e. sell ASX 200 Futures). The ETF does not own or short sell any shares. You will get dividend payouts from owning these ETFs. Dividends are funded through the interest income from the cash within the ETF.
Futures are derivative contracts that allows the ETF to get a magnified (or geared) inverse exposure to the market. For example, it’s possible for the ETF to have a -300% relationship with the ASX 200 index. In this case, when the ASX goes down by 1%, the Future contracts (and the ETF) will go up in value by 3%. On the other hand, if the ASX goes up by 1%, the Future contracts will go down by 3% in value.
The folks at Betashares offer three Inverse ETFs. Two cover the Australian market: Australian Equities Bear Fund (BEAR) and Australian Equities Strong Bear Fund (BBOZ). One to cover the US market: US Equities Strong Bear Fund (BBUS).
BEAR is designed to give you 90% to 110% inverse return to the ASX 200. BBOZ is a magnified version of BEAR, giving you 200% to 275% inverse return to the ASX. BBUS is designed to give you the magnified 200% to 275% inverse return to the US market.
In the 3 months to 31 Jan 2016, these three inverse ETFs have been the 2nd, 3rd and 4th best performing ETFs (when you exclude the commodity ETPs tracking gold, platinum, etc).
The ASX 200 was down -7.3%. In comparison, BEAR achieved +5.0%, whilst BBOZ achieved +12.8% over the period. Compared to the US market dropping by -8.1%, BBUS gained 20.5% in value.
In a downmarket Inverse ETFs will perform well. But when the market turns around, they will start losing value. It is important to also recognise that BBUS and BBOZ have geared impact. Whatever happens with the market, their performance will be the reverse but magnified by 200%+! Make sure you are careful when you use these inverse instruments.
You can view the inverse ETFs listed on the ASX in the ETF Watch Fund Database by selecting 'inverse index' as the management type. Alternatively give Betterwealth a run to build your own virtual ETF portfolio!