Short Story: ETFs

Rebecca Jarvis

When the market tanks, these ETFs soar.

We're talking about ultra-short exchange traded funds.  Investors fretting over the recent stock market selloff may want to take a look at this group of ETFs.

They work like any other ETF and act as open-ended mutual funds in that they can be traded at any time. The ultra-short twist is that they double-short whichever index they are attempting to replicate.

Enviable Returns

In February when the Dow Industrials Average fell 2.8% -- the worst month in nearly two years -- ProShares UltraShort Dow 30 ETF gained 7.3%.

Now with the Dow off nearly 6% from its July 19 record high, ultra-short ETFs are returning a pretty penny.

ProShares UltraShort Dow 30 ETF is up 12.2%. ProShares UltraShort QQQ, which double-shorts the NASDAQ, is up 13.7%. And ProShares UltraShort S&P 500 is up a whopping 16.8%.

Tom Lydon, editor of ETF Trends, says the time to buy is when an index trades below its 200-day moving average because it may "trigger the beginning of a change in trends."

The Russell 2000 Value Index, for example, broke below its 200-day moving average on July 23, 2007. Since then, it is down 10.6%. On the other hand, the corresponding ultra-short ETF, ProShares UltraShort Russell 2000, is up 21.4%.

Ultra-short ETFs also come in sector varieties, like the UltraShort Financials ProShares. With stocks like Countrywide Financial and Bear Stearns getting hammered recently because of credit concerns, the ultra-short financials fund is up sharply -- 28.6% in the last month, and 33.6% in the last three months.

Roger Nusbaum, chief investment officer for Your Source Financial, says he likes ultra-shorting materials as a short-term play. "Any time the market struggles, materials do really poorly," he says. ProShares UltraShort Basic Materials, for instance, is up 26.6% in the last two weeks.

Need To Know

You can short ETFs yourself, but according to Nusbaum there are advantages to letting the investment house do it for you. "If you sell short an ETF, you will have to pay the dividend paid by the fund," he says. "That's not the case with ETFs that themselves go short."  Plus, while you cannot short an IRA, you can buy ultra-short ETFs for your IRA, he says.

ProShares charges a 0.95% expense ratio on its ultra-short funds, considerably more than the average long ETF, but a good deal less than a number of actively managed mutual funds.

At the moment, ProShares is the only firm with ultra-shorts, but Rydex has its own version in the works and should be available by the end of the year.

Of course, because these funds bet on bad times, they take a tumble when times are good.

"If you're going to be in ultra-short ETFs for a long time," says James Pacetti, president of ETF International, "You'll lose money since the market has an upside bias over the long term."

© 2009 CNBC.com