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The Perils of the ProShares UltraShorts

The second article of interest was in the morning's Financial Times. This was an article on the hedge fund Harbinger, and how it had thrown up "the gate" and restricted redemptions. The article went on to describe how Harbinger got the subprime call right, and through six months of 2008 was up more than 40%, yet closed the year with a 27% loss.

A lot of the chat rooms associated with these levered ETFs pointed to Harbinger's ownership of the ProShares UltraShort Financials (SKF) ETF as a validation of these securities as a smart buy (Harbinger owned 3.5 million shares as of Sept 30, 2008, according to the 13-F filings). I wonder now, in light of the second-half performance, how Harbinger feels about the efficacy of this position vs. employing the capital elsewhere.

On the message boards, several people said, "Oberg just doesn't know how to trade these things -- you have to know how to ride the bumps." That is simply a naïve intellectual position to take. Maybe I could have chosen a measurement point that reflected outstanding performance (note: my dates were entirely coincidental ... I just started examining these things right around Thanksgiving), but it really doesn't matter. An efficacious trade or hedge should perform more or less in line with expectations, regardless of the point in time of measurement. If you cannot measure it at any point in time and have it perform as would be expected, then you are in an inefficient positional expression of a view. If you cannot admit that, then you are rationalizing. When you rationalize a position, nine times out of 10 you will lose money.

I stated in the original piece that there are only three reasons someone would buy these:
  • they are uninformed (and indeed, the Journal of Finance research piece I referenced, which was co-authored by someone at the SEC, showed that reduction in margin requirements leads to increase in uninformed traders),
  • they are trying to circumvent the margin rules, or
  • they are attempting to manipulate the markets.

The fact that professional investors could get caught up in these is just mind-boggling to me. Let's give them the benefit of the doubt, and assume that they are not attempting market manipulation -- I'll leave that up to the regulatory bodies to sniff out. (As a parenthetical aside, I will also choose not to debate whether a fund's potential pro rata contribution measuring anywhere from 10% to 40% of a stock's daily volume is meaningful or not (it is...).) Let's also assume that these larger "sophisticated" investors do not need to circumvent the margin rules, as they should have some access to capital, somewhere, if they truly are legitimate and deserving of their "2 and 20." So maybe that just means they are uninformed.
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