Why Short Sector ETFs Aren't So Smart -- Part I

What would you say if you bought an index fund, only to find out that it lagged the benchmark by 30%? 80%? Over 100%? I am sure you'd be dismayed, disappointed and disgruntled.

What if you had perfect foresight and decided at the beginning of this year to go short U.S. real estate and short financials? What if I told you about an easy way to implement these trades, and to implement them with two or three times leverage? You'd expect to clean up, right?

What if I told you that if you were spot-on with your market call, positioned half of your portfolio in each short, you would still be down 23.4% year to date?

That's better than the overall market, sure, but still a little perplexing, I mean, how could you be down for the year with one of the most prescient market calls of all time?

Yet this is exactly what would have happened if you were long the double-levered short-biased ETFs on the U.S. real estate and financial sectors year to date. In fact, one would have been better off being short the double levered long funds vs. long the double levered short funds to implement this strategy.

Given that the double-levered long-side ProShares Ultra Real Estate ETF (URE - commentary - Cramer's Take) was down nearly 80%, one would expect its complement (the ProShares UltraShort Real Estate ETF (SRS - commentary - Cramer's Take)) to be up 80% instead of losing nearly half of its value, given they are based on the exact same index, right?

The same goes with the financial sector ETFs. Given that the double-levered, long-sided ProShares Ultra Financial ETF (UYG - commentary - Cramer's Take) was down nearly 85%, you'd expect its complement (the ProShares UltraShort Financial (SKF - commentary - Cramer's Take)) to be up 85% rather than flat. As the car rental commercial says, "Not exactly..."

What makes this even more bewildering is that ETFs, with their create/redeem process, should eliminate or curtail arbitrage, so there should not be any significant net asset value distortions, and that indeed does not appear to be the case.

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At the time of publication, Oberg had no positions in the stocks mentioned.

Eric Oberg worked in fixed income, currencies and commodities for Goldman Sachs for 17 years before retiring as a managing director.