Portfolio Review: Orol Using Inverse ETFs To Smooth Returns

May 22, 2008

Rather than viewing ETFs that short stocks as trading vehicles, advisor using ProShares as long-term hedges to dampen volatility.


Brian Orol is throwing out his old investing playbook.

"We've got to be more opportunistic these days in looking for good investments," said the Raleigh, N.C.-based advisor. "The old adage that he who hesitates is lost has taken on even more significance these days."

It used to be that most of his client assets were put into diversified portfolios of exchange-traded funds. Those positions didn't change much, if at all. "We're at a point of convergence right now in the economy," Orol said. "A lot of significant factors are coming together at once. It's changing the entire environment for the way we think about investments."

Shifting demographics and global economic change is like "standing on a beach where the sand constantly shifts beneath your feet," he added.

The investment environment is morphing so rapidly that "you've got to change the tools you use to accomplish those same long-term goals," said Orol.

As president of Strategic Wealth Group, his research-focused investment shop uses both fundamental analysis of markets as well as considering technical factors.

Even with the rise in volatility in stocks and flux of world markets, Orol says investors need to remain disciplined. "We don't want to move our focus away from long-term planning," he said. "It's important to stick with a strategy and not let the market whipsaw you every time it changes."

To stay focused and to use the market's gyrations to his advantage, Orol says he's turning to a number of unique tools now available.

Added Flexibility

"There are a number of new ETFs available that allow us more flexibility, both in terms of gaining industry exposure as well as being able to adjust our leverage in the market," he said.

Starting last October, Orol bought shares of UltraShort QQQ ProShares (AMEX: QID). The ETF gives 2-1 short exposure to the tech-dominated NASDAQ-100 index. "It's a great hedging tool. We've kept some of it even as the market came back in March of this year," Orol said.

Unlike some, he sees QID as more of a longer-term investment than a strict trading vehicle. "We're not a market-timing shop. That's not our expertise," Orol said. "But holding an ETF that goes short can really help to minimize volatility in a diversified portfolio."

A good example is this year, he adds. "Our short positions have definitely taken a hit since March when stocks started rallying," Orol said. "But in the past week, QID did well as the NASDAQ fell sharply."

His clients' positions in QID remain slightly above breakeven since he started buying them last year, he says.

"Hedging in a diversified portfolio is almost a necessity these days," Orol said.

In general, only a small portion of his portfolios use ETFs to short the market. "We'll adjust over time the amount of hedging we do," Orol said. "But unless the landscape changes in a material fashion, we'll probably always keep some form of hedging in our strategies."

The firm owns some shares of the UltraShort S&P 500 ProShares Fund (AMEX: SDS) as well. The ETF also provides 200% shorting exposure to an index, in this case, the S&P 500.

Another hedging tool he's used in the past is the UltraShort Oil & Gas ProShares (AMEX: DUG). "We've found mixed results with this ETF," Orol said. "Oil prices change so quickly that it's very difficult to use a double-short fund like this as a good long-term hedge."

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