Given how much price decay there is in inverse (short) ETF's, are the inverse ETF's profitable even in a prolonged bear market?

Question

To me some of these products look like they are designed in a the-house-always-wins manner, especially when one looks at their 1yr or 5yr charts. This observation applies for general ones bearish on like the whole S&P's or for ones even in specific sectors like tech or finance.

Is this always their nature: to have such massive decay? I do understand that there are interest rate payments and upkeep costs associated with them. And assuming there is a bear market, how can attempted to rate them against other potential bearish investments?

Answer 1

In the short term, inverse ETFs (standard or leveraged) perform as advertised. They "almost" negatively mirror the performance of the respective counterpart. What you don't see in that view is that the "almost" is a few basis points of under performance each day which becomes much more significant and obvious when you look at 1yr or 5yr charts. That's the nature of daily decay.

Check out the performance of DJIA, NAZ and Russell ETFs and inverse ETFs during the February correction (1x, 2x and 3x). Daily returns for each were "almost" negatively equal. There's that "almost" again".

In terms of construction, the house doesn't win from the decay and expense within these products. Your broker does nicely but that's irrelevant to this.

I'm not sure how to answer your question about rating these against other potential bearish investments. What others? ETF versus inverse ETF? Shorting? Options? Be that as it may, each strategy has its own merits and disadvantages. For example, with long vs inverse ETFs (same leverage), If the borrow cost is lower than the decay/expense rate of the inverse, simply short the market proxy. I don't think that one will make a significant difference with one over the other. If you get on the right side of the trade (short in a bear), that's where the bang for the buck is. If you buy a 3x inverse and it returns 2.8x instead of what's advertised, is that the end of the world? Make money, be happy!