Inverse S&P500 ETF to provide ballast to my asset allocation as an alternative to Bonds?

JamTomorrow

Reflecting on my pension fund asset allocation in response to recent market contraction I am left wondering if I need to consider, and do more research on an inverse S&P500 ETF to reduce variability in my portfolio performance (eg XSPS).

Books I've read frequently talk of Bonds providing counter correlation to equities but I haven't seen inverse S&P500 ETFs considered/discussed.

This isn't about removing bonds from my portfolio but maybe replacing some of the ballast I want them to provide with an alternative such as this.

Is this something others have considered or implemented in their pension portfolio and any good articles or reading material on this that you would recommend.  Any risks or unintended consequences to watch out for?

Thanks.

gm0

I have not seen any literature suggesting this as a successful volatility reducing approach for a long equities portfolio for drawdown.  When I was getting started with drawdown I looked at it.  Some of these synthetic VIX/XIV and inverted products have a use in day trading position manangement but cost structure and cumulative behaviour makes them less suitable for ballasting buy and hold.  There are process issues with daily cycle and rollup, charges to consider and there is of course the risk a product (particularly a leveraged version) will go pop exactly when it needs to pay out having taken cost premiums up until then.

ERN (early retirement now) ex professional investment management - lays out some options writing strategies and covers this stuff a little.  But even he as an ex pro plays with it and doesn't use it for core portfolio.  T
he articles he wrote on these topics in the drawdown series may be helpful to you to get to grips with why this isn't particularly mainstream.

https://www.msci.com/www/blog-posts/did-hedging-tail-risk-pay-off-/01784814215

Could do with an update to today in terms of numbers but it demonstrates the issues.

EdSwippet

JamTomorrow said:

Reflecting on my pension fund asset allocation in response to recent market contraction I am left wondering if I need to consider, and do more research on an inverse S&P500 ETF to reduce variability in my portfolio performance (eg XSPS).

Do you already hold an S&P500 tracker in your portfolio? If yes, then surely the combination of that with the same amount of an inverse S&P500 tracker would be equivalent to holding cash. That is, each simply cancels out the other. And if no, then you're placing a large bet on the S&P500 falling.

Maybe investigate the difference between uncorrelated and negatively (inverse) correlated. Diversification comes from the first of these, not the second. In practice, purely uncorrelated seems hard to achieve; the best available is usually weakly correlated.

Linton

You certainly want to do more research before you buy an inverse fund as they will lose money over time.

Inverse funds are reset each day. Say you start with £1000 with the S&P500 at 4000

The S&P500 falls to 3800 = a 5% fall -> your £100 rises to £1050
The S&P500 rises to 4000=a 5.26% rise->your £1050 falls to £994.8

or

The S&P500 rises to 4200 = a 5% rise -> your £1000 falls to £950
The S&P500 falls to 4000=a 4.76% fall->your £1050 rises to £995.2

These funds are intended to be bought for the short term perhaps to limit the potential losses on trading.

bostonerimus

You are thinking too hard about things, I would not short the S&P500.

JohnWinder

'Regardless of what you might or might not think about the possible usefulness of a long-term leveraged position achieved by using margin, leveraged and inverse ETFs are completely different products and do not give remotely comparable results.

In short, leveraged and inverse ETFs are specialized products, which present major risks as long-term buy and hold investments and little rewards in return for such risks. The use of such products as part of a regular asset allocation should be discouraged.'

https://www.bogleheads.org/wiki/Leveraged_and_inverse_ETFs#.22differ_in_direction.22

[Deleted User]

EdSwippet said:

JamTomorrow said:

Reflecting on my pension fund asset allocation in response to recent market contraction I am left wondering if I need to consider, and do more research on an inverse S&P500 ETF to reduce variability in my portfolio performance (eg XSPS).

Do you already hold an S&P500 tracker in your portfolio? If yes, then surely the combination of that with the same amount of an inverse S&P500 tracker would be equivalent to holding cash. That is, each simply cancels out the other. 

If you go long and short S&P 500 then the outcome is worse than holding cash because there are costs to consider.  So, in practice you would not buy “inverse” but simply sell all or a portion of your S&P500 holdings. Then you really do hold cash as a net outcome.

The strategy the OP is talking about can be implemented by other means. And it often is, usually by hedge funds. All you need to do to limit downside is buy an option to sell at a certain price.  The strategy is also popular if you want to short, which can generate unlimited losses. To limit this exposure one would buy a call option. 

While there are ways of doing these things, I wouldn’t recommend it.