Two Investment Options for Bearish ETF Investors: Inverse ETF and Shorting ETF

Abstract

A high liquidity, low expense ratio and the possibility to conduct arbitrage allow exchange-traded funds (ETFs) to be used for short sales. Bearish investors can also buy inverse ETFs. This paper aims to outline two investment approaches for bearish ETF investors and the differences between these two approaches; it also aims to examine the relationship between price and an indicator of volume and evaluate the final positions in selected ETFs in selected periods. Short ETFs dominate in simplicity, flexibility, paying out dividends and especially in the limited size of the loss. On the other hand, their structure, which demands daily rebalancing, causes substantial deviation from the benchmark in the long-term and leads to a higher expense ratio, and lower liquidity increases bid-ask spreads. Negative aspects of ETF short selling lie in unlimited loss, high borrowing costs, the need for margin accounts, variability of loan fees and the possibility of a transaction recall by the lender. On the contrary, margin operations enable potentially higher appreciation of capital by generating rebate rates. Our results show that with the decrease in value of the most used ETFs, short interest is growing for those funds where there is a very strong negative correlation implying hedging tendencies. Short selling proved to be a more advantageous strategy in the observed period of market downturn, as well as in 2011–2017, due to negative returns, however, by applying margin trading inverse ETFs turned out to make less losses. Sector-oriented inverse ETFs are the exception, where the largest differences between these two strategies are recorded. However, the final conclusion of the suitability of one of the analyzed strategies depends on the market volatility and the direction of the market itself.

The Implementation and Refinement of Western Hedge Fund Strategy in Chinese Market: Index Rebalancing of CSI 500

“…The passive investment strategy, such as ETFs, will follow CSI 500, buying the added and selling the deleted. [5] Therefore, as new stocks are added to the index, the demand for the added stocks will increase, resulting in an increase in price until the new equilibrium point is reached. Similarly, as new stocks are deleted from the index, the supply for deleted stocks will increase and then the price will decrease to a lower equilibrium point.…”

Exchange traded funds in Europe and the US

“…With short selling an investor is exposed to practically unlimited position growth and therefore losses, whereas in the case of an inverse ETF, the loss is limited by the volume of funds invested into the position. Also, Inverse funds' simplicity, dividend payments and the loss limited by the amount of purchase favor them compared to short selling (Chovancová et al 2019).…”