Good article from Bob O’Brien in Barron’s warning about the dangers of 2X Short funds: Beware of Leveraged Short ETFs.

Its not just the short leveraged ETFs, its all of the leveraged ETFs that have the same slippage characteristic over time.

As anyone who has ever traded them can tell you, they fail to track their benchmark dollar for dollar. This is because they use futures contracts and swaps, and are reset each day. The slippage from their targets us anywhere from 200 to 500 basis points — the longer the time held, the greater the potential slippage. (We use the 2 for 1 leveraged ETFs, both long and short).

Barron’s:

“These short ETF funds – and there are 39 of them available – afford investors the opportunity to capitalize on a market decline in a relatively inexpensive, accessible fashion. Like all ETFs, these products are listed, so they trade like stocks. Their associated fees are half – or less – than the cost of comparable mutual funds. And because many of these products use leverage – mainly through the use of swaps – investors can effectively double or triple their exposure to a market decline at no additional cost or risk. So if you’re betting that the market is going to fall, leveraged short ETFs have a lot of appeal, at least conceptually. Their performance in the last three months testifies to that appeal. Since the S&P 500 topped out this year on April 23rd, the ProShares UltraShort S&P 500 has gained 20%. By comparison, the S&P 500 itself has lost 12%.”

Note that the ProShares UltraShort S&P 500 (SDS) has about $3.7 billion of AUM, and is the most popular ETF of its kind . . .

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Source:

Beware of Leveraged Short ETFs

Bob O’Brien

Barron’s AUGUST 23, 2010

http://online.barrons.com/article/SB50001424052970203534304575441874200791144.html