How to become Ultrabroke

Mark McHugh is a financial professional and former associate of a large investment firm.
He provides fee-based financial planning and tax preparation services in the Philadelphia area.

Editor’s Warning: Although Mark McHugh shares a surname with a respected contributor to The Big Picture Café, we’d like to state for the record, that Mark doesn’t know Jack.

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Are You getting ETF’d?

Objective: UltraShort Blah-Blah ProShares seeks daily investment results, before fees and expenses, that correspond to twice (200%) the inverse (opposite) of the daily performance of the Blah-Blah Index.

Remember when you first heard about these leveraged ETF’s? That little part of your brain that actually wants you to survive started flailing its’ arms saying, Hold on there, Chief…. Double the gains?…How does this work?…How much fees and expenses?…Can this possibly work?…Remember? And you said, “Shut-up brain, I know what I’m doing.” Double your pleasure, double your fun, double your risk of cardiac arrest while just sitting in front of a computer. Now look at you, after a handful of “Plaxico” incidents, trying to externalize the whole thing.

Real men don’t read prospectuses, I always say. So when the eggheads at ProShares (and others) offered to warp time and space just for me, I was excited. Now, thanks to the recent performance of the SRS (ProShares Ultra-short Real Estate) and URE (ultra-long), I believe I’ve discovered a wormhole to a whole new dimension of excitement.

Take this past Monday, for instance:

While not able to understand to understand the Theory of Relativity, I can multiply by 2 (and subtract). Is a couple percent off target anything to be concerned about? The difference amounts to about $0.13 for URE holders and about $4.35 for SRS longs. I’d multiply that by the number of shares outstanding, but the only data I can find (MSN) says there are 8m shares of SRS outstanding (it traded over 15m today). And Yahoo says the expense ratio is 0.95% (sometimes the jokes just write themselves).

It’s not fair to rush to judgement based on one anomaly, right? So, how do you like your anomalies?

Intraday:

Perhaps it is noteworthy that these price deviations vs. IYR (Barclays DJUSRE tracking ETF) observed on 12/03/08 at 2:36 were indicative of the direction the index would move in by the close.

The Eight week long anomaly:

The Final Anomaly:
As of 12/03/08, the DJUSRE index is down 52.7% YTD, meanwhile SRS has returned a measly 3.6% (not 105.4%). Ironically, shorting the URE (which is essentially the same trade) has netted better than 85%. Sickeningly Ironic, is the idea that shorting equal dollar amounts of both URE and SRS (a neutral trade) would have produced a gain of almost 41%.

Conclusions:
I believe that these weapons of financial self-destruction (leveraged ETF’s) are as structurally flawed as all the other “innovative” financial products that flew in under the regulators radar in recent years. The URE/SRS pair is just the first to reach critical mass. SKF/UYG should be next to crack (it may have already, I don’t follow it in detail). It certainly seems that shorting them is far safer than buying them. And the next time that little voice says, How does this work?….maybe I’ll listen.

I hope that I’m wrong about the nature and sustainability of these funds, because there has been a deluge of them recently (“3x”, “Ultra-commodities”, etc.). I’ve just got a bad feeling that this is where unintended consequences come from.

I’ve heard several pundits say that they are looking to see the markets go through an “apathy” stage. I just can’t see that happening with these babies around. Too exciting. Oh, I almost forgot to mention that a lot of these things trade options too? Might as well just douse myself with gasoline and have somebody hand me a lit sparkler.

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Sources:
http://finance.yahoo.com
http://moneycentral.msn.com