db x-trackers ShortDAX Daily ETF should be viewed as a specialty satellite holding best suited for active traders who understand how inverse funds work. This fund can provide a short-term hedge for investors looking to protect a portfolio consisting mostly of German equities if the market falls. It can also be used as a short term trading tool and provide the opportunity to speculate on a decline of the German market. This fund is not suitable as a buy and hold investment.
Prospective investors should understand the risks involved in inverse ETFs, especially the effects of path dependency and compounding on returns. Because of the daily compounding arithmetic, investors are not guaranteed to get the index's inverse return for any holding period longer than one day. As an example, imagine that the DAX falls from 100 points to 90 points in one day, a decline of 10%, and then climbs back to 100 the next day--an increase of 11.11%. On the first day, the fund should rise by 10% to 110 but then fall by 11.11% the next day to 97.78.
It should be noted that using db x-trackers ShortDAX Daily ETF has a couple of advantages in comparison to shorting the DAX index. This is an effective strategy for investors trapped in a long position during a prolonged bear market. By using this fund, they could avoid the taxes, spreads and broker fees that they would otherwise face if they sold their entire portfolio. Another advantage of buying this fund over shorting the index is that investors can’t lose more money than they have invested in it, unlike a traditional short position, which exposes investors to the potential for unlimited losses.
The short- to mid-term economic outlook for heavily export-oriented Germany has deteriorated. Stubbornly high unemployment and falling manufacturing activity threatening the recovery of the Eurozone, and the slowdown in Emerging Market economies – in particular China – in the first quarter of 2013 have taken its toll on the once resilient largest economy in Europe.
Economic data have been somewhat mixed. Industrial output in the Eurozone rose by 0.4% in February, although it rose by 0.9% in Germany. However, a sharp downward revision of Germany’s January data muted the Eurozone picture, hinting to a slower than expected recovery. Also, unemployment in the Eurozone remains at its highest level since the euro’s creation, reaching 12% in February. Meanwhile unemployment in Germany remains at a low 5.4%. Some data indicate that the Eurozone contracted again in the first quarter of the year. The PMI for the Eurozone dropped further into contraction territory at 46.5 in March, while Germany’s PMI (50.6) remained just above the 50 threshold separating contraction from expansion. As a result of rather weak economic data, the German government’s economic advisor cut the GDP growth forecast for 2013 from 0.8% to 0.3%.
Further sentiment data has added to concerns on the overall health of the German economy. In April, the ZEW index dropped for the first time in five months from 46.5 to 36.3; well below market expectations for a milder fall to 43.0. According to ZEW, the sharp decline in sentiment was consistent with the release of economic data also falling short of expectations
Additional factors likely weighing on sentiment include a weaker Japanese yen impacting the external competitiveness of Germany’s high-end manufacturers, and a slowing Chinese economy.
Germany’s Bundesbank also contributed to the generally gloomy outlook by cutting its GDP growth forecast, partly on the negative effects of the still recessionary state of the Eurozone’s peripheral countries. By contrast, despite the weak data, the IMF has raised its 2013 GDP growth forecast slightly to 0.6% from a previous 0.5%.
Looking forward and taking into consideration the export-oriented nature of its economy, Germany could benefit from any improvement in the outlook of the US and Asian economies, despite a recent slowdown in China.
Companies in the basic materials sector, the largest sector in the DAX, generally operate in a highly cyclical environment and are subject to fluctuating commodity prices. Rising raw material costs can put pressure on these firms’ margins and dampen demand. However, any deterioration of the Eurozone sovereign debt crisis should put downside pressure on the euro, in turn providing support to exports.
Consumer goods companies, representing the second largest sector in the DAX, are more dependent on the strength of German domestic demand. Low unemployment (5.4% in February) and low inflation (1.8% vs. 1.7% in the Eurozone) should serve to support consumer confidence. In fact, Germany’s volume of retail trade ticked up slightly in February by 0.4% m/m.
The ShortDAX is an index calculated by Deutsche Boerse that is linked inversely to the daily movements of the DAX index. In addition to inverse DAX share price performance, the index also accrues interest payments resulting from the investment strategy in twice the amount of the overnight rate (EONIA). Interest accrues in the same amount for the investment volume as well as for the funds received from short-selling. The DAX index comprises the 30 largest companies trading on the Frankfurt Stock Exchange and represents approximately 80 % of the free-float adjusted market capitalisation of the Prime Standard Segment. The value of the DAX is based on free-float market capitalization and trading volumes. The weighting of an individual constituent is limited to 10% of the index’s value. The index weightings are reviewed quarterly and the index’s composition is reviewed once a year in September. The DAX is one of the few major country indices that is calculated on a total return basis, i.e. dividends are constantly reinvested into the index. Basic materials is the primary sector represented, with 25% of the index's value, followed by consumer goods (19%), financials (17%), and industrials (14%). Bayer is the largest component of the DAX with a 10% weighting. Rounding out the top three constituents are Siemens and BASF.
db x-trackers ShortDAX Daily ETF uses synthetic replication to track the performance of the ShortDAX index. To achieve this return, the fund enters into a fully-funded swap agreement with parent company Deutsche Bank. Under this agreement, the proceeds of fund holders’ investment in the ETF are transferred to Deutsche Bank in exchange for the performance of the ShortDAX index (net of fees). Deutsche Bank will deposit collateral in an account opened in its name with State Street Bank Luxembourg, the custodian of the ETF, segregated at the fund level and pledged for the benefit of the fund. The collateral typically comprises large cap equities from OECD countries and bonds, including government and corporate bonds. These securities will not be lent out to any counterparties. The company applies haircuts to the collateral’s market value, which results in overcollateralisation equivalent to 107.5%-120% of the fund’s NAV. Collateral value is monitored daily by third party State Street Global Advisors (SSgA) to ensure that the exposure to the counterparty remains over-collateralised, i.e. the net counterparty exposure is maintained at zero.
In the case of an enforcement event—which could be any of a number of a wide range of actual and/or poten¬tial default or termination events on the part of Deutsche Bank—the ETF will be entitled by Luxembourg law at that time to enforce the pledge and sell the collateral assets without giving prior notice to Deutsche Bank.
The db x-trackers ShortDAX Daily ETF is a capitalising fund, so it doesn’t make any dividend payments.
Inverse ETFs tend to have higher expense ratios than standard index ETFs. The fund levies a total expense ratio of 0.40%. Other potential costs associated with holding this fund which are not included in the TER include swap costs, bid-ask spreads and brokerage fees.
The only alternative to db x-trackers ShortDAX Daily ETF that provides the inverse performance of the DAX is Amundi ETF Short DAX 30. This Paris-listed fund levies a lower TER of 0.34% but this fee may come at the expense of lower liquidity. As these inverse funds are only appropriate for short holding periods, investors should probably focus more on considerations such as trading costs rather than annual fee differences of 6 bps. Higher liquidity may allow ETF trades to be executed at tighter bid-ask spreads.
For investors with high risk tolerances, db x-trackers, Lyxor and ETFX offer funds that provide twice the negative daily performance of DAX. However as they employ a daily leverage of 2, they can potentially generate even greater losses. Their total expense ratios are also higher (0.60%).
Moreover, RBS offers monthly leveraged short ETF on the DAX which mitigates partly the compounding issues intra-month. This ETF levies a TER of 0.60%.