What is an Inverse ETF?
Here is a quick answer to the question, ‘What is an inverse ETF?’ Inverse ETFs (sometimes called short funds or bear ETFs) are a type of exchange traded fund that aims to return the opposite return (-1X) of some index or benchmark over a specified period of time, usually one day. Inverse ETFs are a relatively small subset of the total ETF universe and are naturally more popular when the index it tracks is not doing well.*
Unlike traditional mutual funds or exchange traded funds, inverse ETFs have no actual ‘assets’. Their holdings are derivative contracts, often swap agreements, with counterparties, often financial institutions. As such, the funds are subject to counterparty risk of these counterparties.
There are several categories of inverse ETFs, including stocks, bonds, commodities and currencies. Most are considered single inverse ETFs since they aim to track their benchmark inversely on a one-for-one (-1X) basis. But they may also be leveraged and inversely track their benchmark twice (-2X) or even three times (-3X). There are even relatively new lightly leveraged inverse mutual funds which provide a leverage quotient of -1.25x.
For the right investor or account, an inverse ETF can be viewed as an active management tool to hedge or reduce market risk in an investment portfolio. They may also be used opportunistically to take advantage of specific market opportunities.
For more information on the basics of inverse ETFs, please review our inverse ETF basics page and pay attention to the benefits as well as risks they pose for an investor. The performance history of many inverse ETFs is relatively short so many people are probably left asking “what is an inverse ETF?” But, it’s not certain how they will hold up in an environment of high volatility. Every investor’s individual circumstances are different so you should consult with your financial advisor before trading or adding inverse ETFs to your investment portfolio.