March 18, 2025
8 mins read
People normally think of growth when they talk about ETFs. They follow an index, ride its upward wave, and maybe do better than the index. But what about an Inverse ETF? That's a whole other thing. It does better when markets fall than when they rise.
An Inverse ETF is a type of exchange-traded fund that is traded on the stock market. It follows a benchmark, but it does it in the opposite way. Its design lets investors make money when the underlying index goes down in value through derivatives.
These funds are often called "Bear ETFs" or "Short ETFs" because they use methods like short-selling, futures, and swaps. It sounds hard at first, but the main idea is simple: when the market goes down, Inverse ETFs go up. Traders typically use them as a quick strategy to protect themselves or bet on price drops.
Let's go back to something we know: a regular ETF. Let's say you choose an NIFTY 50 ETF. You're thrilled when the index goes up because your units grow up in value. Simple.
Now turn that logic around. When the index goes down, an Inverse ETF goes up. If the NIFTY 50 goes down, the price of your Inverse ETF unit goes up. It's like looking in a mirror.
But here's the catch. Futures contracts and swaps are quite important to these funds. Fund managers don't just sit back and watch; they trade derivatives to keep that "inverse" exposure going. This product isn't something you can just hold on to for years. In truth, they are usually geared for daily betting, not long-term parking.
A lot of newcomers get confused by the word "daily." If you hold an Inverse ETF for more than a day, the math of compounding means that your returns may not be exactly what you expected them to be. Yes, it can insulate you against short-term market shocks, but the key word here is short-term.
These products go the opposite way of a stock index, like the NIFTY 50. They are mainly made for short-term plans instead than long-term investing.
These funds are designed to move in the opposite direction of bond indexes, so they do well when bond prices go down, which happens a lot when interest rates go up in the market.
They are linked to certain industries, like banking or technology. The fund goes up when that sector goes down, which gives you specific exposure to market downturns.
They are riskier than regular ETFs since they try to make more money when an index goes down. But as the sound is louder, losses also get bigger quickly.
Protect yourself against a downturn - Inverse ETFs can help when the market goes down. They let investors ride the tsunami of bad news instead of being pulled under it.
Easy - You don't have to personally get into derivatives. You only need to buy an Inverse ETF unit. Professionals take care of the complicated futures and swaps.
Affordable - There are no borrowing expenses or margin accounts like there are with short-selling. You only buy units, and the fund manager does the hard work with derivatives.
Getting access to experts - To be successful in short situations, you need technique and time. You pay fund managers to deal with the complicated stuff when you use an Inverse ETF.
Risk of compounding - Because they are set up for daily movements, holding them for more than a day often causes performance to diverge from the predicted inverse correlation.
Risk of derivatives- These funds use derivatives, which can be risky for credit and liquidity. If a counterparty doesn't pay, the fund's value could go down.
Risk of correlation - In theory, returns should move in the opposite direction of the index, but costs, fees, and active rebalancing often disrupt that ideal symmetry.
Risk of short exposure - Volatility and a lack of liquidity can make it harder to make money. Markets don't always go down in neat, predictable ways, and Inverse ETFs can fare worse when things are choppy.
Not everyone should use inverse ETFs. They aren't about creating riches over time; they're more tactical and often last all day. Traders who know how to deal with volatility might find them useful, but casual investors looking for steadiness generally won't.
People who already know how to short-sell and use derivatives will find them more useful. Risk tolerance is quite important here. If you don't like the idea of losing a lot of money quickly, you should definitely stick with regular ETFs or mutual funds.
Traders who have been doing this for a while still add them to their portfolios for diversification or hedging, even if they know they will have to pay greater fees and make mistakes while tracking them.
Comparison parameter | Inverse ETF | Short Selling |
Access to professional expertise | Yes, a fund manager manages your investments. | You have to rely on your own knowledge of market assessment and futures contracts skills |
Risk | Partly borne by the investor, so lower risk appetite required. | Fully borne by the investor, so higher risk appetite is required. |
Investment objective | Gain profits by holding investments for a day in a less risky manner | Gain profits by holding investments for a day in a more risky manner |
Downsides | The downside is limited because you always have the support of the fund manager and broker. | Higher downsides because you do not get alerts by your fund management house |
Accounts required | There is no requirement for a margin account and futures and options trading account. | Margin account and futures and options trading account need to be opened. |
Transaction charges | Includes expense ratios and other fund management fees | Includes account maintenance fees |
Costs | Generally lower than costs associated with short-selling | Generally higher than costs associated with inverse ETF |
Lending of money | The broker lends money to the fund house, not the investor. | The broker lends money to the investor. |
In conclusion, inverse ETFs are best suited for short-term traders aiming to benefit from daily market movements, as holding them long-term can result in unpredictable outcomes.
These funds carry inherent risks due to their use of derivatives, active management, and higher expense ratios, making it essential for investors to remain aware of volatility, tracking errors, and potential losses.
While they provide access to professional management and indirect exposure to derivative strategies, their suitability lies mainly with traders seeking hedging or diversification during market downturns.
Conversely, long-term investors may find traditional ETFs or mutual funds more appropriate.
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An inverse ETF tries to inversely replicate the underlying index it tracks. For instance, if a NIFTY 50 inverse ETF is tracking the NIFTY 50 index, the value of the ETF will go up when the NIFTY 50 comes down. Usually, inverse ETFs are used as a hedge against volatility during bear market conditions.
An inverse ETF generally enters into futures contracts backed by derivatives between two parties in an anticipation that the market will fall. Once the market declines, the value of the underlying security goes down and the fund house buys those securities at a discount. The difference between the sell price and buy price accrues to the fund house as profits.
Inverse ETFs carry several risks such as counterparty risks, correlation risk, derivatives risk, and short exposure risk. Since inverse ETFs are suitable for investors looking to invest only for a day, this exposes their money to high volatility that may erode investor capital. A counterparty may not honor the terms of the contract which is referred to as counterparty risk. Though the inverse ETF tries to achieve a perfectly negative correlation with the underlying index, it is not realistically possible due to high expense ratios and other fees.
Inverse ETFs provide the services of a fund manager who is an industry professional. Whereas if you want to earn profits through short-selling, you need to rely on your skills and expertise of market analysis and prediction.
As per SEBI, inverse ETFs are not allowed to be traded in India and therefore, you cannot invest in inverse ETFs through Bajaj Broking. SEBI is concerned about investor interests and feels that the volatility associated with derivatives-based contracts cannot be handled efficiently by fund houses or investors. SEBI’s other view is that inverse ETFs can destabilize the market and give rise to speculation that can ultimately harm investors’ interests.
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