VESH: A different inverse ETF

Eight years into arguably the second longest bull market ever, has made short selling seem less a “lonely” activity and more a “suicidal” one as tacking against the euphoria has been a career killer leaving only a handful of exchange-traded products (ETPs) to choose from.  

Our fund database shows 138 inverse products, but taking away those levered ETPs intended for short-term moves leaves just 57 names with total assets of $6.5 billion.  Desperate times indeed for traders who worry about equities potentially topping out, but the recent introduction of the Virtus Enhanced Short U.S. Equity ETF (VESH) brings a novel strategy to one of the most challenged segments of the ETP market just when it needs it the most. 

Launched in late June, VESH is radically different than most of the inverse equity funds on the market beginning with its stated goal of outperforming a -100% of the total return of the S&P 500 Index when nearly all inverse equity products are passive funds that merely attempt to deliver the negative performance of a well-known benchmark minus their fee.  That focus would make VESH’s nearest competitor, the AdvisorShares Ranger Equity Bear ETF (HDGE) an actively managed product that shorts individual stocks based on bottoms-up stock research, a very different approach than most inverse or bear market funds that rely on futures (see “A better short”).  While VESH is also actively managed, its strategy is laid out in a rules-based fashion more in-line with a strategic beta fund, while employing a more nuanced strategy than larger inverse funds.  

In fact, VESH is very much a strategic beta fund built around the concept of momentum, probably the most widely known and exploited market inefficiency, except its focus is obviously on capturing negative rather than positive momentum.  The fund is essentially two strategies, with 50% of its assets in a monthly rebalanced inverse S&P futures position that should help keep the fund correlated with the broader market while the remaining 50% is built around an immediately recognizable sector rotation strategy.  

At the end of each month, the GICS (Global Industry Classification Standard) sectors comprising the S&P 500 are ranked by their trailing nine-month returns with the five worst performing sectors being singled out to be sold short using futures contracts.  While investors might sometimes wish for heavier exposure to smaller segments of the market, like energy stocks or utilities, the short positions are weighted proportional to how much they make up of the S&P 500 to keep the fund from developing unintentional sector wagers.  

And despite lacking a long track record, it’s easy to see the potential advantages of such a strategy in a market where there remains a wide degree of dispersion between sector returns, even as a 5% correction has become a distant memory. Consider this August, the S&P 500 delivered a relatively flat, 0.31% return while beneath the surface there was a 700-basis point performance gap between the worst performing sector (energy stocks of course) and high-flying healthcare and utility names.  VESH, with its strategy of sector rotation and monthly reconstitutions was able to deliver a solid 1.23% gain for August, outperforming the S&P 500. The passive Profunds Inverse S&P 500 Fund (SH) was down 0.21% in the same period.  

Finally, if that performance wasn’t enough to put VESH on your watchlist, the fund also has a relatively low management fee of 55 basis points despite being actively managed and frequently rebalanced.  That low fee puts VESH closer to the majority of long-only, passive strategic beta funds rather than existing short strategies which usually come with a higher price tag.  In fact, VESH’s fee is substantially below both actively managed HDGE (175 bps) or passive funds like SH at 89 bps, which significantly reduces the potential cost for investors anxious to hedge their equity exposure.