In May 2022, major German insurance company Allianz agreed to pay $6 billion in compensation to investors, and its U.S. asset management unit pleaded guilty in a criminal trial over the collapse of several investment funds. They were supposed to create an alpha regardless of market conditions, but lost $7 billion of $11 billion in assets under management during the COVID-19 crisis.
The Allianz case highlights the risk of running a US asset management company, which has become more risky over time because the court system allows for much larger amounts to be paid out than in other jurisdictions if court cases are won. With this in mind, the amount of risk information in US investment product prospectuses continues to grow. Ironically, the longer prospectuses become, the less useful they are for investors, as they take too long to read and require more legal acumen.
Risk disclosure also varies by product, with some reporting investment risks upfront than others. One category that describes the risks very clearly is inverse ETFs, which aim to provide the reverse performance of indices like the S&P 500. For example, the Short S&P 500 ETF (SH) ProShares website is dominated by a large section called Important Considerations. , which is rather unusual since such risk warnings are usually at the bottom and in a relatively small font size. It seems that inverse ETFs are particularly risky.
In this research note, we will look at the specifics of inverse ETFs.
The universe of inverse ETFs
We focus on inverse exchange-traded products and funds (ETPs and ETFs) traded in the US, which are a collection of around 100 products that collectively manage approximately $20 billion. With over $7 trillion in total assets under ETF management in the US, this represents a small niche in the ETF market.
The universe of inverse ETFs spans various asset classes such as stocks and fixed incomes, broad indices such as the S&P 500, as well as niche sectors such as the SPAC. The average management fee is 0.95% per annum, which is exceptionally high for an ETF.
For this analysis, we have selected three inverse ETFs that provide negative exposure to the S&P 500 with leverage ranging from 0x to 3x. These three ETFs have over 10 years of experience and manage over $5 billion in assets.
We see that investing $1,000 in 2009 would wipe out investment capital for both leveraged inverse ETFs and result in an 80% drawdown for one unleveraged one. The S&P 500 has mostly been in a bull market since the global financial crisis, and shorting the stock market didn’t work.