Invest like a hedge fund with one simple ETF

Date: Thursday, July 16, 2009
Author: Today's Financial News

The average investor has no shot at hedge-fund style strategies. It takes big money and a staff of gurus. But ProShares is trying to change all of that with the introduction of its latest ETF. Did it get the job done?

By Andrew Snyder, TodaysFinancialNews.com

Baltimore – (TFN): Even with the current economic calamity rightly or wrongly blamed on the world’s ever-leveraged derivatives market, plenty of investors are tossing their money into exotic strategies once used solely by the spreadsheet magicians working in the back offices of Wall Street hedge funds.

While long-short strategies are considered far from exotic in today’s world of default swaps, pooled securities and derivatives of derivatives, it is only recently that the average Joe-the-Investor can get his hands on a ready-mix fund designed to mimic the popular leveraged strategy.

Leave it to ProShares to offer an ETF and make it even easier.

With the popular ETF manager releasing an ETF yesterday, the ProShares Credit Suisse 130/30 ETF (NYSE:CSM), designed to copy the action of the Credit Suisse 130/30 Large-Cap Index, investors are renewing their interest in long-short strategies.

If you are not familiar with a 130/30 strategy or any of its variants, it is a fairly simple concept.

Let’s say an investor  has $1,000. He uses the money to go long on $1,000 worth of stock. Meanwhile, he shorts $300 worth of stock (30%) and uses the proceeds to go long on even more stock.

In other words, the investor is long 130% of his initial investment and short 30%.

It is a good strategy… as long as it works.

Cannot afford mistakes

Make the right moves and long-short investors will easily use the leverage created by the short sales to outgun the markets.

But make just a single miscalculation or get a correlation wrong and the whole thing could come crumbling down. As always, short investors need to know their risks.

Like so many popular ETFs (the slew of leveraged inverse funds come to mind), adequately mirroring an index sounds easy but is quite difficult in practice.

Investors have things like management fees to worry about, liquidity and in the case of the newest ETF, finding an effective way to short 30% of the funds ever-changing assets.

In this case, ProShares appears to have entered a swap agreement.

That fact immediately piques my attention. With one entity directly betting against ProShares’ short stake, it opens the door to manipulation, even if ever so slightly. We have all heard the boiler room tales over the past eight months.

When done carefully, as proved by so many hedge funds, a 130/30 strategy can lead to market-beating profits. But the “proprietary” method of determining what to short and what to go long on had better be sound.

It is important to remember ProShares is, first and foremost, looking for a profit. With a management fee of almost 1% on this one, it likely has a winner on its hands.

Investors need to look at that figure and realize they are already a step behind the benchmarks they are trying to beat.

This ETF will have its time to outshine the broad market. It will come when Wall Street finally agrees on what direction the nation’s economy is headed.

While volatility remains high and correlations stand the possibility of falling apart nearly as quickly as they did last fall, an investment as delicate as a long-short strategy creates more risk than it eliminates.

This one will be interesting to watch.