Inverse ETF

A fund whose published objective is a negative multiple of an index's return for a defined period. It does not sell the constituents short. It holds swaps, futures and cash whose combined exposure is negative, and the objective names both the multiple and the period, most commonly the inverse of the daily return. The period in the objective is the whole of the contract with the holder: the fund undertakes nothing about any other interval.

To hold the stated exposure the fund rebalances at the end of every period, adjusting its derivative positions to the new asset value. That mechanical reset is what makes the objective daily rather than cumulative, and it is also what produces the effect holders most often miss. Returns compound, and because the exposure is reset each day against a changed base, a sequence of moves that returns the benchmark to where it started does not return the fund to where it started. The gap widens with volatility and with the length of the holding period.

That divergence is arithmetic, not a fee and not a tracking failure, and it runs against the holder in choppy conditions and can run in the holder's favour in a sustained one directional move. Practitioners call it volatility drag or path dependency. Two further points are commonly missed: the fund carries the credit exposure of the derivative counterparties it deals with, and its expense ratio sits above that of a plain index fund because the derivative positions have to be maintained.