What is EUM? (Pros, Cons, and Strategies)

With the continuous evolution of global markets, investors often look for means to hedge their portfolios against downturns, particularly within emerging markets. One such instrument that promises to serve this purpose is EUM. This blog post will delve into what EUM is, its pros and cons, and its investment strategies.

What is EUM?

EUM stands for ProShares Short MSCI Emerging Markets ETF.

EUM is an exchange-traded fund (ETF) designed to provide investors with inverse exposure to the daily performance of the MSCI Emerging Markets Index. This means that if the MSCI Emerging Markets Index declines, EUM aims to provide a corresponding positive return, making it a tool for investors looking to profit from or hedge against declines in emerging market equities.

Key Features of EUM

• Provides inverse exposure to the daily performance of the MSCI Emerging Markets Index
• Utilizes derivatives such as swaps and futures to achieve inverse returns
• Intended for short-term investment, particularly trading or hedging purposes
• Offers a cost-effective means for investors to short emerging markets without directly using futures or options

Investors seeking to hedge their portfolios or gain from potential downturns in emerging markets find EUM a suitable investment option. However, it's crucial to note that EUM is not designed for long-term holding due to the daily rebalancing of its inverse exposure.

EUM Composition

EUM's inversely corresponds to the MSCI Emerging Markets Index, which consists of a diverse range of large and mid-cap companies across 26 emerging market countries. The index includes various sectors like technology, financials, consumer goods, and more. However, EUM does not directly hold these securities but instead uses financial derivatives to achieve its inverse performance objective.

Pros of EUM

Hedging Against Market Downturns

EUM allows investors to hedge their portfolios against potential downturns in emerging markets. This makes it an effective tool for risk management, particularly during periods of market volatility or economic uncertainty in emerging economies.

Potential for Positive Returns in Declining Markets

EUM offers the potential for positive returns during times when emerging markets are declining. This can be particularly useful for investors with bearish outlooks on these markets or those seeking to balance their long positions in other emerging market stocks or funds.

Cost-Effective Shorting Strategy

EUM provides a more cost-effective and accessible means for individual investors to short the emerging markets compared to using futures or options. It eliminates the need for margin accounts and the complexities associated with short selling individual securities.

Cons of EUM

Not Suitable for Long-term Investment

EUM is primarily designed for short-term trading and hedging. Due to its daily rebalancing mechanism, holding EUM for extended periods may result in performance that deviates significantly from the inverse of the benchmark index over time.

High Volatility and Risk

Inverse ETFs like EUM are often more volatile and riskier compared to traditional ETFs. Investors must be prepared for significant price fluctuations, and the potential for losses if the underlying index does not move as anticipated.

Potential for Tracking Errors

The use of derivatives to achieve inverse returns can sometimes lead to tracking errors, where the fund's performance diverges from its intended inverse exposure to the benchmark index. This can result in unexpected returns for investors.

EUM Investment Strategies

Given its unique characteristics, EUM is suitable for specific investment strategies primarily focused on short-term market movements and risk management.

Short-term Trading Strategy

EUM is best suited for investors with a short-term bearish outlook on emerging markets. By holding EUM for short periods during anticipated market downturns, investors can potentially capitalize on declining market trends. It's essential to monitor market conditions closely and make timely adjustments to avoid prolonged exposure.

Risk Management and Hedging

For investors with significant exposure to emerging market equities, EUM can serve as a hedging instrument. By taking a position in EUM, investors can protect their portfolios from potential losses during volatile or bearish market periods. It's a useful strategy for managing the overall risk of a diversified portfolio.

Tactical Allocation

EUM can be used as part of a broader tactical asset allocation strategy. Investors may allocate a portion of their portfolio to EUM during times of expected market turbulence or negative economic indicators in emerging markets. This tactical allocation helps to balance the risk and return profile of the overall portfolio.

Conclusion

EUM offers a unique investment tool for those looking to hedge against declines in emerging markets or profit from such downturns. However, its suitability for short-term trading and risk management requires investors to be vigilant and strategic in their approach.

Understanding the pros and cons of EUM and employing appropriate investment strategies can help investors navigate the complexities of emerging market volatility. Whether using EUM for short-term trading, as a hedging instrument, or as part of a tactical allocation, it's important to remain informed and proactive to maximize its benefits.