Profiting off the bear market with Short-Biased ETFs

What is a Short-Biased ETF?

A Short-Biased ETF (also known as an inverse or bear ETF) is a structured product that usually uses derivatives to profit from the decline of certain securities. Shorting is the act of borrowing a security to sell it, then subsequently buying back the security to return to the lender at a later date with the hope that the security has declined in price.

Short-Biased ETFs usually have exposure to certain indexes, whether that be broad market indexes such as the S&P 500 or the Dow Jones Industrial Average, or specific sectors such as Gold Miners, Financials etc. 

The reason that these ETFs are also considered “bear” ETFs is that they profit off the decline in prices of securities. Declining prices, in general, are not viewed favorably since most market participants have a long bias and would benefit from rising prices. For example, anyone who owns a house would want to see the value of their home increase over time.

Why use a Short-Biased ETF?

The act of shorting securities requires a margin account since if you were to short sell a security, the potential downside is technically unlimited (prices can theoretically have no upper limit). This limits the risk from the brokerage's perspective by ensuring that you have posted enough capital in your account to meet margin requirements.

Short-Biased ETFs are a lower-cost way of gaining short exposure as you do not need to post margin.

Buyers of Short-Biased ETFs usually do so for one of the following two reasons:

1. Expectation of a decline in underlying security prices
2. To hedge against an existing position

Examples of Short-Biased ETFs

Some examples of Short-Biased ETFs include:

SH (ProShares Short S&P500)

AUM: $2,656M

Expense Ratio: 0.90%

YTD performance: +22.7%

DOG (ProShares Short Dow30)

AUM: $268M 

Expense Ratio: 0.95%

YTD performance: +15.6%

Risks and considerations of Short-Biased ETFs

Some significant risks and considerations for Short-Biased ETFs make them unsuitable for long-term investments.

1. Risk of compounding – Short-Biased ETFs held for more than a single day will drag on performance since most Short-Biased ETFs have a single-day investment objective (they aim to match single-day returns, not long-term returns). This risk is heightened during times of extreme market volatility.
2. Risk within derivatives – Short-Biased ETFs utilize derivatives in many cases. These derivatives introduce new risks, including liquidity risk, credit risk, counterparty risk etc.
3. Tax inefficiency – daily resets cause ETFs to realize short-term capital gains that are not offset by equivalent losses.
4. Greater costs – while Short-Biased ETFs may be less costly than short-selling individual securities, they may still be more costly than their long-biased counterparts.

Data for this article is as of June 14th, 2022.