Are Pension Funds Ready for Inverse ETPs?

There are now more unemployed people in the United States than in the entire state of Illinois, the fifth largest state in the U.S. That’s according to Wall Street Journal blogger, David Wessel who last week put America’s 13.9 million into perspective. As he notes, “If they were a country, the 13.9 million unemployed Americans would be the 68th largest country in the world…”

It’s easy to see why so many think we’re headed into another global recession. With EU on the brink of dissolution, the US downgraded and powerhouse China looking even more vulnerable to the slowdown in the west, it’s getting really hard to be positive about future economic growth.

Pension funds haven’t typically turned to ETFs to manage volatility and risk – but a recent article in Pensions and Investments notes that at least a handful of them are actually turning to leveraged and inverse ETFs to deal with increased market volatility.

As the writer points out, US$66 billion Ohio State Teachers’ Retirement System owns 325,000 shares of ProShares UltraShort S&P 500 ETFs. Along with pension funds, more and more hedge funds are now big users of leveraged and inverse exchange-traded products.

Given that ETFs now claim 11% of the total trading volume on stock exchanges globally it’s easy to see why they’re being used to gain short-term exposures. Leveraged and inverse products say they can deliver two or three times the return of the correlated asset or the inverse of a particular index in a trading day.

Inflows into them have surged in the wake of the US downgrade—in particular, ETPs based on the Chicago Board Options Exchange Volatility Index or VIX leapt 35.41% on August 4th.

But do they make sense of pension funds? Skeptic say they’re risky and that the costs don’t outweigh the benefits. But the market is still young—and there’s lots of room to evolve and grow. So the jury is still very much out—and if markets get any worse, leveraged and inverse ETPs could soon become another tool for plan sponsors to deal with a lot of the ugliest volatility that’s still to come.