Dangerous Markets Make the Case for Inverse ETFs

There are many ways to define the gradual shift in the stock and bond markets of recent weeks. ETFs, as usual, have been a great way for financial advisors and investors to track what’s going on at a high level and get granular too.  

For instance, while the SPDR S&P 500 ETF Trust (SPY), which for many advisory clients is “the market” for better or worse, a 5% decline for April through late afternoon on Friday might be the end of it, or it could be the start of something much bigger.  

And while the S&P 500 Equal Weight ETF (RSP)’s is off about 6% so far this month, it hung in there on Friday and is now up 1.7% on the year.  

But the bigger issue for advisors and their clients could be what is happening with the so-called Magnificent Seven. The magic is gone, at least temporarily, as Nvidia’s 10% plunge Friday followed recent sizeable drops in Apple and Tesla. One by one, the market leaders are falling, or at least dipping hard. The $835 million Roundhill Magnificent Seven ETF (MAGS) was up 20% for the year through last Friday, then promptly gave half of it back last week. 

Investor behavior has adapted over the years in one important respect. People tend to accept great volatility in market areas such as the Magnificent Seven, under the guise of “I’m a long-term investor.”  

Investors have been conditioned to “buy the dips because the strategy has worked most of the time with the most recent examples in the major index rallies in 2020 and 2022. But now what? 

Responding to Last Week’s Stock Rout 

The somewhat orderly decline last week, in which there were no “sell everything” moments for the market, and the strong start to the year for 2023’s equity leaders, has put advisors in a strong position in communicating with clients. The market is dipping, not panicking, at least for now. That might afford them the time to introduce the concept of portfolio defense beyond what we’ve all been reacquainted with lately. ETFs that own T-bills, such as the $19.8 billion iShares 0-3 Month Treasury Bond ETF (SGOV), still yield north of 5%.  

Defense comes in many forms, and among the most compelling for advisors to understand in these moments are inverse ETFs, specifically those that do not employ leverage. The latter form is more for traders, and compliance departments often do not allow them anyways.  

However, for advisors with clients sitting on large gains from owning Nasdaq 100 leading stocks, but preferring not to sell due tax reasons or feeling like they’d be “timing the market,” single inverse ETFs can be akin to fixing a wobbly table by wedging something between the leg that is off-kilter and the floor. 

Among the first single ETFs advisors can research is a set that has been around since at least 2007 and has sufficient assets and liquidity for many accounts. Each one simply delivers the opposite return of the target index daily.  

3 Inverse ETFs Advisors Should Know 

The longest-running single inverse ETFs that seek to deliver the opposite return of the indexes in their names are the Proshares Short S&P 500 ETF (SH), the ProShares Short Nasdaq 100 ETF (PSQ) and the ProShares Short Russell 2000 ETF (IWM). This ProShares hedging trifecta has approximate assets under management of more than $1.1 billion, $550 million, and $170 million, respectively. 

One key due diligence point for single inverse ETFs is that since they are managed to the daily return of the index, but in the opposite direction, the math can work in a way that if the market declines by, say 10%, the inverse ETF may not go up by 10%. But with so much history behind this trio, at least there is a large sample size of data for advisors to analyze. 

Whether it is to hedge, help maintain core ETF or stock positions, or to attack a down market, single inverse ETFs have been time-tested. Advisors may never get a better time to scout them, determine how best to deploy them, and gain recognition from their clients as having provided tangible value to their portfolios, and lifestyles, just when they most needed that.