In a week in which the Dow Jones Industrial Average has surrendered more than 10% of its value, inverse ETFs have continued to thrive.

A screen of the top 20 performing ETFs tracked by MSN Money for the 4-week period ending October 7th, will return a list that includes 19 inverse ETFs. The only non-inverse ETF is a fund that tracks the performance of the Swiss Franc relative to the U.S. dollar. This fund has averaged a meager trading volume of 1,600 shares, essentially rendering it insignificant.

The top performer over the past 4 weeks has been the UltraShort Basic Materials ProShares Fund (SMN) which has returned a lights-out 76.1% in a little under a month. The fund seeks to return twice the inverse of the daily performance of the Dow Jones U.S. Basic Materials Index. Major components of this index include DuPont (DD), Dow Chemical (DOW), Nucor (NUE) and Alcoa (AA).

If Alcoa’s Q3 results are of any indication as to how this ETF will perform in the coming weeks, its prospects are favorable. On Tuesday, Alcoa kicked off the earnings season with a 47.6% drop in EPS versus its year ago quarter. Revenue for the quarter declined by 5.3% as the price of aluminum has tumbled 32% since reaching an all-time high in July.

Other recent headliners in the ProShares stable have included the UltraShort Russell MidCap Growth ProShares Fund (SDK), the UltraShort Telecommunication ProShares Fund (TLL) and the UltraShort Industrials ProShares Fund (SIJ). Over this same 4-week time period, these ETFs have seen respective returns of 58.7%, 57.2% and 48.8%.

Ideal Timing

In the summer of 2006, the ProFunds Group launched the Short QQQ ProShares Fund (PSQ), the Short S&P 500 ProShares Fund (SH), the Short Dow 30 ProShares Fund (DOG) and the Short MidCap 400 ProShares Fund (MYY). These products were the first ETFs that enabled investors to obtain short exposure to market indices.

In addition to an intriguing concept that can be applied to a multitude of investment strategies, the direction of the broader markets over the past year has allowed inverse ETFs to remain in the spotlight. In June, the Bethesda-based ProShares reported that its net assets had surpassed $20 billion in the two years since its first short ETF product launch.

This achievement made ProShares the fifth largest provider of ETFs in the U.S. In 2008, the firm ranked second among U.S. ETF providers in net flows. "We introduced 64 ETFs in two years, each the first of its kind," said ProShares Chairman Michael Sapir. "Through ProShares, investors have, for the first time, been able to seek profit when a part of the market drops, or hedge a portfolio simply by buying an ETF.”

Among its more popular offerings has been its UltraShort Financials ProShares Fund (SKF) which looks to return twice the inverse of the performance of the Dow Jones U.S. Financials Index. The fund has a market cap of approximately $4.2 billion. It has benefitted from the recent misfortunes of companies such as American Express (AXP), Bank of America (BAC), Citigroup (C) and Goldman Sachs (GS).

Year-to-date, SKF is up 43.6%.

What’s Next

With the broader markets continuing to trend downwards and the CBOE Volatility Index (^VIX) continuing to trend upwards, inverse ETFs will continue to be a force in the investing world. Should these trends reverse; inverse ETFs will continue to remain relevant.

Aside from allowing investors to bet against well-known indexes or sectors, these ETFs give individual investors and financial advisors the ability to create countless variations of traditional index funds by hedging out unwanted exposure to select sectors.

Inverse ETFs have made a major splash in the investing world since breaking on to the scene. And right now they are prospering in these stormy seas while everything else is under water.

Billy Fisher
Analyst, Oxbury Research