Earlier this week I was browsing around the various finance sites (as nerdy as it sounds, I do this for fun) and stumbled upon an article about a new type of ETF coming to the market. Since I did a primer on ETF's a few posts ago, and one of the advantages I mentioned that they had was the ability to invest in unique assets, I felt this ETF was a perfect example of exactly that.
What's This New ETF?
The article is from thestreet.com (founded by CNBC's very own Jim Cramer). Titled 'Long-Short ETF Finally Makes It's Debut', the article describes an ETF the uses an interesting investing strategy in order to amplify returns.
There are two components to this ETF - the long and short. Although they are related in the overall strategy of the ETF, they are essentially the opposite concepts. 'Long' (aka going long or longing) is basically the investing strategy most people use - in effect it's the 'buy low and sell high'. When someone is 'going long', they are buying stock in the hope that it goes up and they can sell it at a higher price later.
Short (aka going short or shorting) is pretty much the exact opposite of going long. In this case you actually sell the stock first (usually after borrowing it from you broker) and buy it back later - hopefully at a lower price. Here, you basically 'sell high and buy low'.
So what the 'Long Short' ETF does is invest all of its assets going long. It then attempts to amplify returns by going short an additional 30% of the assets. Since you sell the stock first when going short, and thereby receive the money for the sale in cash, the fund will then invest those funds to go long an additional 30%. Overall, for every dollar the fund has, there's actually $1.60 invested ($1 long, $.3 short, $.3 long with proceeds from short). It's an interesting and risky way to amplify returns.
My $.02
LIke I mentioned earlier, I think this is an interesting investing approach. If the models being used to determine how to allocate the long and short positions is sound, you can really make some solid returns while still having a natural hedge against adverse market movements.
But before you go ahead and sink a bunch of money in this ETF, you need to understand the risks. Shorting in its basic form is a risky proposition. When you're going long, the most you can lose is 100% (the stock goes to $0). However, when you're going short, the downside is unlimited - the stock can go forever up. Furthermore, by shorting you're going against the grain. Most people still want the market to go up (esp. the companies who's stocks are on the market). As a short position holder, you're fighting that and opening up to downside risk.
To add to those risks, you're taking the proceeds from the short position to go long. So you can have a double adverse scenario if you're short position goes up and your long position goes down. In this case, not only are you losing money in the short position, you don't even have as much power to buy the short position back (called 'short covering') since the proceeds are worth less as well. This can lead to some very tricky 'rock and a hard place' type scenarios.
The bottom line here is, 1) I would never recommend anyone try this long/short strategy on their own (i.e. without investing in this ETF or other professionally managed fund). However, if you have the appropriate risk appetite and the fund proves itself to be sound, I would look into possibly investing in the fund. Assuming the models are sound, this can be an excellent way to make some serious profits. Just make sure you understand the risks! :-)
Questions/Comments/Feedback?
Please don’t hesitate to let me know of any questions or comments you have about this post or any other. If you want me to write about something else investing related, do let me know!
The Standard Disclaimer:
The stuff I just wrote above is my opinion and my opinion only. Please do not take it as fact. Perform all necessary research and analysis prior to acting on anything I've said above. This includes consulting with a financial advisor.
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