A typical exchange-traded fund (ETF) is a basket of shares that exposes you to a range of investments. Beginner investors may choose an ETF as a first investment because alongside providing diversification, it can be less volatile than investing in single stocks.
However, buyers beware! Not all ETFs are created equally. Some types of exchange-traded funds are not suited to beginners, and investing in them could leave you feeling out of your depth with your skills and risk tolerance.
Inverse exchange-traded funds
Most ETFs we discuss on Hatch are made up of holdings that might include shares in companies, cash, or bonds. They aim to profit from these holdings’ increasing value. Inverse ETFs are made up using various derivatives, aiming to profit from a benchmark or index dropping in value.
💡 Note: Inverse ETFs might appear in the 'most traded' search on the Hatch platform because they are day-traded, and typically see higher volumes of activity relative to your standard ETF, which is often bought and held.
Features of Inverse ETFs
An inverse ETF aims to deliver the opposite return to the index or benchmark that it is tracking.
You profit from the decline in value of the benchmark, rather than the increase in value.
Higher management fees (0.75% - 1.1%) vs 0.03% to 0.1% for a standard S&P 500 ETF.
Daily rebalancing can have a compounding effect on returns in the positive, but also causes something called volatility decay.
Many inverse ETFs are also leveraged.
The way that inverse ETFS are rebalanced is also very different, and more complex;
Inverse ETFs are rebalanced daily using swaps, futures and short positions to achieve the correct inverse exposure.
As a comparison, the Vanguard S&P 500 is rebalanced quarterly, by adjusting holdings to match the target index's stock weightings.
🚨 Important: Inverse ETFs are considered by most investors to be daily trading investments. They are rebalanced daily, and are not designed specifically for a buy-and-hold investment strategy
Why do investors buy inverse ETFs?
Investors might consider Inverse ETFs when they think the markets are volatile or declining. Investors looking to hedge their investments could buy and sell inverse ETFs rather than shorting stocks (which you can’t do on the Hatch platform).
How can I spot an inverse ETF?
When browsing ETFs on the Hatch platform, inverse ETFs will often have ‘daily’ or ‘inverse’ in the title or description.
Before buying an inverse ETF, ask yourself if you:
Understand the risks associated with using leverage
Understand the potential consequences of investing in a daily leveraged ETF
For bear funds, understand the risks associated with shorting
Intend to monitor your investments actively
Direxion is a financial company that offers exchange-traded funds, and specialises in both inverse and leveraged ETFs. There is an excellent learn section on their website with videos explaining how they work; https://www.direxion.com/leveraged-etf-education.