Contrarian investors seeking to capitalize on stocks market declines can profit during a bear market using an inverse exchange-traded fund (ETF). A bear market is typically defined as a situation where securities prices fall 20% or more from recent highs amid widespread investor pessimism. The spread of COVID-19 and its effect on investor sentiment triggered a collapse in securities prices earlier this year. Inverse ETFs are designed to make money when the stocks or underlying indexes they target go down in price. These funds make use of financial derivatives, such as index swaps, in order to make bets that stock prices will decline. Unlike shorting a stock, though, investors in inverse ETFs can make money when markets fall without having to sell anything short.

Key Takeaways

  • The 2020 bear market lasted from February 19 to March 23, and the S&P 500's total return was -33.8% from peak to trough.
  • The inverse ETFs with the best performance during the 2020 bear market were RWM, DOG, and HDGE.
  • To achieve their inverse exposure, the first two ETFs make use of various swap instruments, and the third ETF holds short positions in different stocks.

The inverse ETF universe is comprised of about 10 ETFs, excluding leveraged ETFs and ETFs with less than $50 million in assets under management (AUM). The last bear market took place from February 19, 2020 to March 23, 2020, during which the total return for the S&P 500 was -33.8%. The best inverse ETF during the 2020 bear market, based on its total return between the two dates above, was the ProShares Short Russell 2000 (RWM). We examine the 3 best inverse ETFs of the 2020 bear market below. All numbers in this story are as of August 19, 2020.

Inverse ETFs can be riskier investments than non-inverse ETFs, because they are only designed to achieve the inverse of their benchmark's one-day returns. You should not expect that they will do so on longer-term returns. For example, an inverse ETF may return 1% on a day when its benchmark falls -1%, but you shouldn't expect it to return 10% in a year when its benchmark falls -10%. For more details, see this SEC alert.

ProShares Short Russell 2000 (RWM)

  • Bear market return: 55.4%
  • Performance over 1-Year: -19.6%
  • Expense Ratio: 0.95%
  • Annual Dividend Yield: 1.02%
  • 3-Month Average Daily Volume: 2,829,481
  • Assets Under Management: $433.3 million
  • Inception Date: January 25, 2007
  • Issuer: ProShares

RWM seeks to provide a daily return, before fees and expenses, that is -1x the daily performance of the Russell 2000 Index, an index which tracks the performance of the small-cap segment of the U.S. equity market. The ETF makes use of both ETF and index swaps to achieve its inverse exposure. Since the -1x exposure is for a single day, investors holding the fund for longer than a day will be exposed to compounding effects, causing returns to deviate from the expected inverse exposure. 

ProShares Short Dow 30 (DOG)

  • Bear market return: 47.3%
  • Performance over 1-Year: -18.1%
  • Expense Ratio: 0.95%
  • Annual Dividend Yield: 0.90%
  • 3-Month Average Daily Volume: 1,529,351
  • Assets Under Management: $411.2 million
  • Inception Date: June 21, 2006
  • Issuer: ProShares

DOG aims to provide a daily return, before fees and expenses, that is -1x the daily performance of the Dow Jones Industrial Average (DJIA). The Dow is an index that tracks 30 large, publicly-owned blue chip companies on the New York Stock Exchange (NYSE). The ETF provides inverse exposure to these 30 stocks through the use of various swap instruments. Since the inverse exposure is daily, investors holding the fund for longer periods of time should not expect -1x performance. The fund uses DJIA swaps to obtain its inverse exposure. 

AdvisorShares Ranger Equity Bear ETF (HDGE)

  • Bear market return: 47.3%
  • Performance over 1-Year: -36.2%
  • Expense Ratio: 3.12%
  • Annual Dividend Yield: 0.27%
  • 3-Month Average Daily Volume: 1,093,326
  • Assets Under Management: $149.1 million
  • Inception Date: January 26, 2011
  • Issuer: AdvisorShares

HDGE seeks to achieve positive returns by shorting stocks listed on U.S. exchanges. The ETF uses a combination of quantitative and fundamental factors in order to build a portfolio of equities to short. Good candidates are stocks of firms with low earnings quality or aggressive accounting practices. However, shorting stocks is expensive, which results in high ETF fees.  The fund's three biggest shorts are Canon Inc. (CAJ), a Japan-based manufacturer of copying machines, printers, cameras, and lithography equipment; Pros Holdings Inc. (PRO), a provider of business software services; and Snap-On Inc. (SNA), a tool and equipment manufacturer.