talking point | the blog at LeeHudsonTeslik.com

Yesterday Izabella Kaminska wrote an excellent blog post for FT Alphaville on some of the not-so-visible risks associated with ETFs. Many ETFs, and particularly those trying to track commodity indexes or leveraged or inverse investments, have drawn heat of late for failing to effectively track their respective benchmarks. I had actually been looking at related charts a few days ago. I’m posting one below:

The red line is the S&P 500 index. The blue line is the ProShares Short S&P 500 ETF, which seeks to replicate the inverse of the S&P (before fees and expenses). The ETF has an expense ratio of 0.95%, so you can reasonably expect that it will lag the exact inverse of the S&P by about 1% per year, or perhaps a little more once you factor in the firm’s administrative expenses as it deals with dividend payments, taxes, etc. In fact, over the past year, the ETF has underperformed its benchmark by 36.1% (the S&P has fallen 23.26%, so its inverse has risen 23.26 percent; the ETF, meanwhile, has fallen 12.84%). If I bought an ETF seeking to track the inverse of the S&P, and the S&P lost over 23% in a year, I would be pretty annoyed if I also lost money (and significant money at that).

Chart via Google Finance