Traders embrace inverse ETFs to counter volatility
Inverse ETFs (Exchange Traded Funds), which have gone through a slow pace of development since they were launched in Hong Kong in 2017, enjoyed a surge in trading volume last month as investors used the product as a hedging tool to counter sharp declines in stock markets decline.
Inverse ETF is a kind of exchange-traded funds designated to profit from declines in the value of the index or benchmark it tracks. In another word, when the tracking index declines 1%, the price of the inverse ETF will rise 1%.
Worst week for stocks best week for Inverse ETFs
The US stock market experienced its largest single-week decline in February, which also affected the Hong Kong stock market. Hang Seng Index plunged 3,094 points in one week, posting its worst one-week drop by points in history. On the contrary, inverse EFT products like CSOP Hang Seng Index Daily -1x Inverse Product (7300) gave a significant return to investors in the bear market.
Jennifer Li, an ETF analyst at CSOP Asset Management Limited, said that Inverse ETFs have become a new favourite of investors when they lose confidence in the stock market, fuelling the trading volume of the HSI Daily -1x Inverse ETF to HK$3.21 million on February 7 and February 8.
In Hong Kong, issuers including China asset management, CSOP Asset Management, MIRAE Asset, Samsung Asset Management and E Fund Management first introduced Inverse ETF products to Hong Kong in March 2017.
Inverse ETF is commonly used to short-sell and hedge. Jennifer said, most of the Inverse ETF investors were institutional investors and they bought inverse ETFs to hedge their short-term downside risks when stock markets were volatile.
Compounding effects of inverse ETF may multiple the loss
As Inverse products strictly track the one-day inverse return of the specific index, the return may deviate from relevant performance if investors hold the products for more than one trading day when markets fluctuate wildly.
Dickson Chen, a managing director of CITIC CLSA, said, "Inverse ETF products will have compounding effects over one trading day. It performs better in case of continuous decline of the exact index. However, if the stock market fluctuates, the Inverse product may record losses."
Take the HSI Daily -1x Inverse ETF as an example. If the Hang Seng Index increased 10% on Monday, decreased 10% on Tuesday, rose 11% on Wednesday, and declined 9% on Thursday, the investor who holds the Inverse ETF product will lose 4% due to the cumulative return.
Brain Roberts, a senior vice president and head of Exchange Traded Products of HKEX, was quoted by Ming Pao as saying that the Inverse ETF is more suitable for those investors who pay attention to the daily operation of the stock market.
Lower risk compared to Warrant and Bear Certificate
The inverse products approved by the Securities and Futures Commission (SFC) are temporarily prohibited from leveraging, which means its leverage ratio is only one time.
"Unlike warrant and bear certificate which contains some characteristics like ongoing devaluation, the implied volatility and the forced recovery mechanism, inverse ETF has a much lower risk with its one-time leverage ratio. The most significant loss of inverse ETF is just the investors’ principal," said Jennifer.
Several factors should be considered when investing in inverse ETFs. Jennifer said when investors choose between different HSI inverse products, they should take the liquidity, tracking error and trading spreads into consideration.
As for choosing between different index’s inverse products, "it is the investment decision, market factors and also the fundamentals that need to be taken into account by investors," Jennifer added.
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