Established in February 2010 by ProShares, the UltraPro Short QQQ (Nasdaq: SQQQ) is an inverse-leveraged exchange-traded fund, or ETF, that tracks the Nasdaq-100 Index. This index is composed of the largest companies, both domestic and international, listed on the Nasdaq stock market; the Nasdaq excludes financial institutions. Company holdings are prioritized by total market capitalization.
The inverse-leveraged strategy for SQQQ means it attempts to reproduce a daily investment result that is roughly opposite the daily performance of its underlying index, and then multiply those results by a certain factor. The stated objective of SQQQ is to triple the opposite results of the Nasdaq-100.
This means investors in SQQQ are preparing for the greater nonfinancial stock market to struggle. Since the Nasdaq-100 tends to be heavily weighted toward technology, telecommunications and health care stocks, the SQQQ should tend to perform well when these sectors perform poorly.
All inversely leveraged funds are made up of financial derivatives, and sometimes even derivatives of derivatives. To achieve the opposite of a specific asset, the fund managers have to trade in short positions and swaps, which essentially are bets the underlying security or investment performs poorly.
The fund provider for SQQQ, ProShares, is a self-described "alternative ETF company." The company was launched in 2006 and focuses on specific, targeted and relatively risky satellite holdings. Most of its ETFs are moderately small or very small, and SQQQ is no exception; total assets under management, or AUM, in mid-2015 were just over $315,000.
SQQQ carries a relatively high expense ratio at 95 basis points. This should not be surprising, since the fund strategy requires occasionally liquefying derivative contracts before their optimal point; in-kind redemptions are very tricky for inverse-leveraged ETFs.
Suitability and Recommendations
It is paramount that investors understand SQQQ is a daily-targeted inverse ETF. ProShares designed this for short-term, high-risk and high-reward gains in the event the Nasdaq-100 struggles. This fund is not suitable for a long-term hold; investors who buy-and-hold SQQQ find their returns badly damaged by expenses and decay.
Several key factors prevent SQQQ from serving as an acceptable core holding in an investors portfolio. The first is the short-term focus of the fund; it is not a buy-and-hold ETF. Another area of concern is the fund size; tiny ETFs such as SQQQ can go through wild fluctuations and are always close to closing altogether.
The share prices for SQQQ also bank on a deviation from historic market performance. The Nasdaq-100 Index does not perfectly correlate with total stock market performance, but it is certainly a cyclical index. Since the general trend of the Nasdaq is to grow over time, the long-term outlook for a 3x inverse-leveraged ETF is bleak at best.
Before an investor considers buying SQQQ, he should fit a very targeted profile. First and foremost, the investor should have knowledge of and be comfortable with an inverse-leveraged ETF. Second, the investor must be able to trade quickly, or have an adviser/broker who can do the same, to avoid decay.
The investor must also be comfortable with volatility. SQQQ carries a trailing five-year beta of -2.77 and an astoundingly low alpha of -20.82. Its three-year trailing deviation is close to 30, and it has a Sharpe Ratio below -2.0. While these are considered somewhat in line with the fund category, they are considerably more risky than the average ETF or mutual fund.
There are some advantages to having a daily-targeted leveraged ETF. For example, the fund is considerably more liquid than other funds of its size; average daily volume exceeds 6.5 million trades, or more than one-third of all outstanding shares.
Overall, SQQQ best serves as a very specific and small satellite holding in an aggressive investor's portfolio. It is probably best used as a countercyclical buy for those who are convinced large-cap stocks will suffer in the very near future.