SPDN - HDGE: A Niche ETF We'd Like To Like But Don't Right Now

Summary

• HDGE is the type of ETF I should really like. But despite having followed it since its 2013 inception, I just can't endorse it.
• The premise of HDGE is solid: find companies that are overvalued due to tricky accounting, and short them.
• But somewhere along the way, this inverse equity ETF failed to distinguish itself from simply buying unleveraged inverse index funds.
• HDGE will have moments of glory, but the overall tenure of this ETF is not the mind-blowing type that would prompt us to favor it over traditional short/inverse peers.
• I rate HDGE a Sell, even though I wish I didn't have to.

By Rob Isbitts

Strategy

AdvisorShares Ranger Equity Bear (HDGE) is a specialized ETF that focuses primarily on short-selling of stocks. Short sales involve borrowing stock in anticipation of that stock going down in price. If it goes down, you can return the stock and book a profit. If the stock goes up, your loss is infinite. HDGE is an actively-managed ETF, so its managers aim to profit from short sales, but also not to get "caught short" on many positions in such a way that the fund takes on big losses.

At the core of the fund's investment process is a reliance on forensic accounting. This graphic from HDGE's website outlines that process. The key factors they look for in an attractive short position are low earnings quality and/or aggressive accounting. The latter might just be the nature of company management, or something more nefarious, depending on the situation. A downward trend in earnings guidance is another "red flag" the managers of HDGE look for.

Proprietary ETF Grades

• Offense/Defense:Defense

• Segment:Inverse

• Sub-Segment:Active Equity

• Risk (vs. S&P 500):Similar

Proprietary Technical Ratings

• Short-Term (next 3 months):Sell

• Long-Term (next 12 months):Sell

Holding Analysis

HDGE is currently short about 68 stocks, and the rest of the portfolio is in cash, largely to back those short positions. All current positions are under 5% of the portfolio, and most holdings are between 1.5% and 3.5% of assets. Importantly, HDGE's holdings turn over at a very high rate. The latest turnover figure is about 1500%. That's not a misprint. And it implies an average holding period of about 3 1/2 weeks for a short position.

Strengths

The best things about HDGE are its intentions. There are very few ETFs on the market that actively short. This one does. And, if you look at the larger short positions on any given day, you are likely to find some of the "cool kids" stocks. In other words, the ones that have seen their prices fly higher on little or no earnings. Those of us who invested professionally through the Dot-Com Bubble and Global Financial Crisis appreciate anyone who makes it their business focus to try to profit from the "bad actors" in the stock market. And, this ETF has had some strong periods, where it outperformed the S&P 500 Inverse ETFs like ProShares Short S&P500 ( SH ) handily.

Weaknesses

Unfortunately, despite those good intentions, HDGE has just not distinguished itself from simply "shorting" the S&P 500 through an inverse index ETF. And, HDGE's expense ratio is massive compared to its peers. That has a lot to do with "short proceeds" the fund receives being considered part of the expense ratio. The irony is not lost on us that one of the biggest reasons this ETF probably fails to meet many investors' screening criteria is because of an accounting quirk, as noted above.

Opportunities

HDGE can be an opportunistic part of a portfolio, for investors who want the potential to profit from a sustained decline in a basket of fundamentally-flawed companies. However, that is not something that happens often. And when it does, there have been few times in this ETF's history where it has added enough value to make up for the many periods of underperformance versus the inverse of the S&P 500.

As the fund's website states, HDGE is a vehicle to try to benefit from the managers' ability to identify "operational deterioration or manipulative sales and revenue recognition." The ETF has over $150mm in assets, and I suspect that figure represents investors who are deep believers in the process here.

Threats

However, while we don't dwell too much on past performance with ETFs tied to indexes, this one is basically a bet on the manager's ability to generate alpha versus the more straightforward alternatives. There are several ETFs that track the 1X Inverse of major indexes, including the S&P 500, Nasdaq 100, Russell 200, and Dow Jones Industrial Average. We just don't see enough "there, there" to produce a positive opinion on HDGE.

Conclusions

ETF Quality Opinion

Despite the lackluster overall view of this ETF, if there is one that could suddenly become attractive in a deepening bear market, it is this one. So, while we don't see the merit currently, with so few actively-managed short-focused equity ETFs on the market, we do keep this one on the shelf, just in case.

ETF Investment Opinion

HDGE gets a Sell rating. But we'll see if there is reason to reconsider that if the equity bear market continues, as we expect it will.

For further details see: