Inverse ETFs Can Help You in a Recession Depending on Your Risk Appetite
Inverse ETFs may appeal to investors in a recession, except that you would need to watch your risk appetite. Let's see how they work and what types are available.
Aug. 12 2022, Published 8:58 a.m. ET
An inverse ETF may be the investment product you need to make money in a market where other investors are losing market. How do inverse ETFs work? What types of inverse ETFs are there? Can an inverse ETF help you in a recession?
The standard ETF that offers exposure to a basket of stocks is designed to help investors get diversified exposure to the market easier. Diversification is an important strategy to apply if you want to succeed in the securities market. The inverse ETF also gives investors exposure to a basket of securities, but it works a little differently. For example, an inverse ETF is about making short-term profits rather than diversifying a portfolio.
How do inverse ETFs work and what types are available?
An inverse ETF is also called a “short ETF” or “bear ETF.” It works like shorting a stock. For example, an S&P 500-focused inverse ETF would deliver a gain of 3 percent if the index drops by 3 percent. An inverse ETF may be focused on an index or particular industry.
One type of inverse ETF is designed to amplify potential returns. These are called leveraged inverse ETFs. A 2x leveraged inverse ETF focused on the Nasdaq 100 would deliver returns of 6 percent if the index declines by 3 percent.
An inverse ETF can help you in a recession.
A recession is marked by falling stock prices. That presents an ideal environment to profit with an inverse ETF. What you need to know is that inverse ETFs are designed for short-term bets — usually daily trades. While an inverse ETF may help you make huge profits in a down market during a recession, it’s a strategy better left for those with high risk tolerance.
Investors could consider these inverse ETFs.
If you think that inverse ETF investing is a risk worth taking, these are some of the popular inverse funds you may want to try your luck with. Keep in mind that these are usually short-term bets to give you exposure to the daily performance of the underlying index or stocks.
The ProShares Short FTSE China 50 (YXI) – The fund offers inverse exposure to large-cap Chinese stocks. It may be useful to investors seeking to bet on the decline of large Chinese companies. The inverse fund was launched in 2010. It has an expense ratio of 0.95 percent.
The ProShares Short MSCI Emerging Markets (EUM) – Launched in 2007, the fund gives you inverse exposure to an index made up of emerging markets stocks. The fund may be ideal for investors looking to bet on the weakness of emerging market economies. It charges an expense ratio of 0.95 percent.
The ProShares Short S&P500 (SH) – The fund offers inverse exposure to the daily performance of the S&P 500 index. It may be suitable interested in betting against large-cap U.S. stocks. Launched in 2006, the fund charges an expense ratio of 0.90 percent.
The ProShares Short Financials (SEF) – Launched in 2008, the fund gives investors exposure to an index that tracks U.S. financial stocks. It provides a platform for investors to bet against the U.S. financial sector in the short term. The fund has an expense ratio of 0.95 percent.
The ProShares UltraShort Dow30 (DXD) – This one is a leveraged inverse ETF. It offers a 2x leveraged inverse exposure to the Dow Jones Industrial Average index. The Dow index hosts a basket of 30 companies regarded as backbones of the U.S. economy. Therefore, the fund may be ideal for traders looking to take a short-term bet on the decline of the U.S. economy. Launched in 2006, the fund’s expense ratio is 0.95 percent.
The expense ratio is the annual management fee that funds charge shareholders. The fee varies across funds and it reduces investors’ actual returns. Therefore, you could do better by investing in a fund with low expense ratio. Inverse ETFs usually have higher expense ratios than the standard ETFs.