Shorting Stocks

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New ETF lets investors profit if China's stock market tumbles

By John Spence, MarketWatch

Last Update: 7:20 PM ET Nov 11, 2007

BOSTON (MarketWatch) -- Investors who believe that China's soaring stock market is due for crash now have a new tool to put their money where their mouth is.

Exchange-traded fund manager ProShares last week launched the first ETFs geared to short international-stock indexes, including a fund that seeks to deliver twice the inverse, or opposite, daily return of Chinese stocks.

UltraShort FTSE/Xinhua China 25 ProShare (FXP), which shorts Chinese stocks, is generating plenty of buzz.

"With the FTSE/Xinhua China 25 Index appreciating by nearly 600% in the last five years, there is a great deal of talk of a potential for a 'China bubble,'" said ProShares Chief Executive Michael Sapir.

The new ETF "can be used by investors to protect a portfolio with China exposure from losses or to pursue gains from a falling Chinese market," he added.

Investors who sell stocks short are betting on a market decline since they stand to profit from lower prices, or they want to hedge an existing investment.

In the case of declines across developed international markets, the firm offers Short MSCI EAFE ProShare (EFZ), which is set up to provide daily returns equal to the inverse of the daily performance of the MSCI EAFE Index, a common yardstick for international developed market stocks, minus fees.

Meanwhile, a leveraged version, UltraShort MSCI EAFE ProShare (EFU), has an objective of delivering two times, or twice, the opposite return of the index. For example, if the MSCI EAFE lost 1% during the trading day, the ETF aims to produce a positive 2% return. If the index gains ground, the ETF should post a comparable loss.

ProShares also listed a pair of ETFs for shorting emerging markets stocks: Short MSCI Emerging Markets ProShare (EUM) and the leveraged UltraShort MSCI Emerging Markets ProShare (EEV).

In addition, the firm introduced a leveraged ETF specifically for shorting Japan's market: UltraShort MSCI Japan ProShare (EWV).
Long run seen for short ETFs

ProShares, a unit of money manager ProFunds Group, has been busy in recent weeks building out its lineup of ETFs.

ProFunds is best known for its stable of leveraged and inverse index funds, but the Bethesda, Md.-based firm is a growing player in the booming ETF industry. However, its monopoly in leveraged and inverse ETFs recently came to an end with rival Rydex Investments getting into the business.

ETFs are baskets of securities that trade like individual stocks, so they can be sold short. However, the new ProShares ETFs are designed to automatically short indexes.

The leveraged and inverse ETFs use complex financial instruments such as derivatives to carry out their objective. Although they should do a decent job of delivering performance on a daily basis, investors should expect tracking error over the long term due to volatility and compounding. Also, the ETFs could see dramatic price swings because they employ leverage.

After about 16 months in the business, ProShares now offers 58 ETFs with more than $9 billion in total assets. The firm was the first to introduce leveraged and inverse ETFs, but Rydex is looking to provide some competition in the space.

"We thought they would be popular, but our expectations have been exceeded," Sapir said about the ProShares' ETFs.

Not surprisingly given the recent market turmoil, the three ProShares ETFs with the most assets can short U.S. stocks: UltraShort QQQ ProShare (QID), UltraShort S&P 500 ProShare (SDS) and UltraShort Financials ProShare (SKF).

The inverse financials ETF has been a big winner lately as banking stocks have been hit by massive write-downs and losses as result of the subprime mortgage mess and credit crisis.

Although regular ETFs can be shorted, Sapir said it's often difficult for individual investors to borrow the shares. Therefore, ProShares is launching leveraged and inverse ETFs for sectors that already have traditional ETFs covering them.

For example, Select Sector SPDR Financial (XLF) is the most popular of the many ETFs tracking the financial sector. Barclays Global Investors runs an emerging markets ETF, iShares MSCI Emerging Markets Index (EEM), which follows the same index that the new ProShares fund shorts.

Likewise for iShares FTSE/Xinhua China 25 Index (FXI), which is tied to an index of the 25 largest and most liquid Chinese companies that trade on the Hong Kong Stock Exchange. So far this year through Nov. 8, the fund has gained 65.5%, making it one of top-performing ETFs year to date.
Rydex steps up

ProShares is getting some competition in the market for leveraged and inverse ETFs.

Rydex of Rockville, Md., last week launched its first such ETFs on the American Stock Exchange. The firm listed funds that provide twice the return, and also double the opposite performance, of large-cap, midcap and small-cap U.S. stocks.