Shorting China With ETFs?

June 16, 2011

If you believe Nouriel Roubini that China’s economy is a house built on a fault line, you’ve got plenty of short-selling options. So, what you’ll need is guts and creativity.

This time, “Dr. Doom” foresees a hard landing for the Chinese economy after 2013. But, as investors well know, the market may move sharply before the data show a full-blown economic pullback.

I think it’s important to note that, when it comes to China, the ETF market affords investors shorting possibilities that don’t really exist in the world of individual stocks.

Despite the difficulty of shorting well-known Chinese stocks such as Renren (NYSE: RENN) or Shen Zhou Mining & Resources Inc. (AMEX: SHZ), as FT highlighted in a recent piece, there are plenty of ways to short Chinese equities using ETFs.

This could turn out to be another special quality of ETFs. But that’s putting the cart before the horse, because first you have to decide that you do, in fact, want to short China. Moreover, as I said, what’s needed before all else is an appetite for risk and a bit of creativity.

Inverse ETFs

The most straightforward options are three inverse ETFs currently trading: the ProShares Short FTSE/Xinhua China 25 (NYSEArca: YXI), the ProShares UltraShort FTSE/Xinhua China 25 (NYSEArca: FXP) and the Direxion Daily China Bear 3X (NYSEArca: CZI).

These three funds, respectively, offer single-, double- and triple-inverse exposure to the Chinese market via two different indexes, including the one on which the $7 billion iShares FTSE/Xinhua China 25 Index Fund (NYSEArca: FXI) is based.

Of course, with any leveraged fund, you have to be ever mindful that most of them—including the three I mentioned—rebalance daily. That means their returns can deviate significantly from their underlying indexes, as the chart below shows.

Over the past year, as FXI returned 4 percent, the single-exposure inverse fund, YXI, fell 12.8 percent. The double-exposure fund, FXP, lost an astounding 26 percent. These crazy numbers show that managing these kinds of funds can be too tall an order for many investors.

Here’s another crazy fact that makes me wonder if things aren’t a bit unhinged at the Securities and Exchange Commission: You can own an inverse ETF in an IRA, and yet outright short selling is prohibited in such retirement accounts. Go figure.





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