By Rob Isbitts
I don’t often cite an ETF’s prospectus directly in my ETF profile reports. But I will here for good reason. “ProShares Short Dow 30 (NYSEARCA:DOG) seeks daily investment results, before fees and expenses, that correspond to the inverse (-1x) of the daily performance of the Dow Jones Industrial AverageSM.”
I cut and pasted that from the website of ProShares, the creator of several single-inverse ETFs that have been the mainstay of the portfolios I have run professionally, going back to their inception in 2006. Prior to that, if an investor wanted to have a fund that, by its design, aimed to deliver the opposite of the Dow, there were mutual funds that did so. But the ETF wrapper and the ability to buy or sell during the trading day to precisely target your entry and exit points is something that DOG and others of its “breed” has brought to investors.
Many investors will tell you that inverse ETFs are day-trading and swing-trading vehicles only. I agree if the fund uses leverage. But in my experience with these ETFs, they can work over longer time periods. Frankly, I think they get a bad rap in some corners of the investment world. But as someone who has used them for a very long time, owning them for months at a time has been a huge alpha generator, especially in bear markets.
Proprietary ETF Grades
Sub-Segment: US Equity
- Risk (vs. S&P 500): Low
Proprietary Technical Ratings*
Short-Term (next 3 months): D
Long-Term (next 12 months): D
* Our assessment of reward potential vs. risk taken
(Rating Scale: A=Excellent, B=Good, C=Fair D=Weak, F=Poor)
DOG is set up like its single inverse ETF peers. The holdings are a group of swap contracts, arranged privately with large banks (BNP Paribas is currently the largest single swap counterparty). Those swaps are buffeted by an investment in US T-Bills. The ETF’s managers work each day to maintain a level of short exposure to the DJIA that allows DOG to pursue its goal of returns the same as that index, just with the opposite numerical sign.
You won’t find too many people that are as enamored with single inverse ETFs as I am. They have been a significant contributor to my portfolio construction efforts over the decades. As my core portfolio approach is about playing offense and defense at the same time, having a toolbox full of ETFs that I expect to do the opposite of the DJIA, S&P 500, Nasdaq 100, Russell 2000, EAFE or other equity indexes is the epitome of the “defense” part of that equation. And, in a year like last year (2022), DOG and its peers can be used to implement a wide variety of ETF arbitrage strategies, as I explain further below.
Let’s return to what ProShares (or at least, their attorneys) say about DOG: “Due to the compounding of daily returns, holding periods of greater than one day can result in returns that are significantly different than the target return, and ProShares’ returns over periods other than one day will likely differ in amount and possibly direction from the target return for the same period.”
In other words, there is potential for investors to be disappointed if, say, the Dow goes up 20% and DOG drops more than 20%. Or, if the Dow goes down 20% and DOG goes up less than 20%. In my time using these, I know that’s always a risk, given the ETF’s structure. But even a small amount of drag on the return still makes the concept of single inverse ETFs a helpful one, in my view. After all, there are not many places to hide at that point in the bear market cycle when nearly all stocks drop together.
I’ll also point out that our proprietary risk rating versus the S&P 500 is “Low” but that is just by a bit. The Dow has been less volatile than the S&P 500 over the years, but not by very much. In fact, DOG has a historical Beta of -.89 to the S&P 500, so it has been about 10% less volatile, and in the opposite direction of the S&P 500 (naturally, since DOG is an inverse ETF).
The Dow was barely down last year, and as of this writing, it is actually up about 2% over the past 12 months. So DOG was not as big a winner to the downside as ETFs shorting the Nasdaq or S&P 500. In fact, as I highlighted in a Seeking Alpha article not too long ago, the DJIA was in the midst of a historically-high return spread over the Nasdaq.
While the Nasdaq 100 and S&P 500 Indexes still look troublesome over the intermediate-term, there is increasing technical evidence that at least a short-term upside breakthrough is possible across the stock market. But if that move fails to occur or is short-lived, we could enter the phase of this bear market where the Dow joins the rest of the equity gang and heads south. That is when DOG could represent a big opportunity. After all, the 30 stocks in that index have been relative market leaders for over a year. The less tech-heavy makeup of the DJIA has been a helper, but now many of those stocks are getting pricey.
Any time an investor decides to own a single inverse ETF, they must realize that by its nature, it will go in the opposite direction of the stock market index it tracks. So, if DOG is used as a “bet” on a down market, without much “long” exposure around it, it can drop a portfolio’s value as fast as the market rallies. And if there’s one thing that bear market cycles are known for, it is quick, very sharp rallies that temporarily halt the downtrend. That’s the main threat here as I see it, if DOG or other inverse ETFs are not considered as part of the overall portfolio structure and allocation.
ETF Quality Opinion
DOG is not in the dog house for me. In fact, it is among my “best in show” when it comes to defensive tools. And, as might be implied by what I wrote earlier in this report, DOG can represent a way for the defense to create some offense, and score points in a portfolio. Sort of like the way an NFL team’s defensive unit can score via interception, fumble recovery or a safety.
ETF Investment Opinion
DOG is a Hold for now, only because the reward/risk tradeoff is not as strong as it was throughout 2022. The stock market is at an interesting juncture, whereby my technical indicators lean bullish. That dampens my immediate enthusiasm for DOG as table-pounding buy. But when the equity market rolls over again (sorry, that was not intended to be a dog pun!), and if the DJIA does not continue its historic outperformance of the Nasdaq 100, DOG could be barking loudly for my attention once again (OK, that last one was an intended dog pun).