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

Investors looking to hedge against declines in specific markets or enhance their portfolio's performance in bearish conditions might consider ProShares UltraShort FTSE China 50 (FXP). Unlike typical long-term investment vehicles, FXP aims to provide a -2x inverse exposure to the FTSE China 50 Index. This makes it a unique tool for sophisticated investors. Today, we'll explore what FXP is, along with its pros, cons, and potential strategies for investing in it.

What is FXP?

FXP is an exchange-traded fund (ETF) designed to deliver two times the inverse performance of the FTSE China 50 Index on a daily basis, before fees and expenses. In simpler terms, if the FTSE China 50 Index goes down by 1% in a day, FXP aims to increase by 2%.

Key Features of FXP

• Inverse Exposure: Seeks a -200% return of the FTSE China 50 Index.
• Daily Reset: The leverage resets daily, making it react to daily index changes.
• High Expense Ratio: Given its complexity, FXP has a higher expense ratio compared to traditional ETFs.

It's important to note that due to the daily reset nature of leveraged ETFs, the returns over periods longer than one day will likely differ from the target return multiplied by the index performance over that same period.

FXP Composition

The ETF focuses on providing inverse exposure to large-cap Chinese companies included in the FTSE China 50 Index. This index covers sectors such as financials, telecommunications, and consumer goods, with major holdings like Tencent, China Mobile, and Industrial and Commercial Bank of China.

Pros of FXP

Hedge Against Market Downturns

FXP can be used as a hedge against declines in the Chinese equity market. Investors concerned about short-term market downturns in China can use this ETF to potentially profit from falling prices.

Short-term Speculation

FXP is also popular among traders looking to capitalize on short-term market movements. Given its -2x leverage, the ETF provides amplified returns on a daily basis, which can be appealing for day traders or short-term speculators.

Portfolio Diversification

Including FXP in a diversified portfolio can help mitigate risks associated with a downturn in the Chinese market. It adds an element of counter-cyclical performance, helping to balance out overall portfolio risk.

Cons of FXP

High Risk

The inverse and leveraged nature of FXP makes it extremely risky, particularly for long-term investors. The daily reset feature means that while the ETF might achieve its target on a daily basis, over longer periods, the performance can deviate significantly from -200% of the FTSE China 50 Index.

High Expense Ratio

With an expense ratio of around 0.95%, FXP is more expensive compared to non-leveraged and non-inverse ETFs. This higher cost can eat into returns, especially if the ETF is held for longer than intended.

Not Suitable for Long-term Investment

Given its structure, FXP is not intended for long-term investment. The daily compounding effect can result in significant performance deviation from the expected hedge, making it unsuitable for buy-and-hold strategies.

FXP Investment Strategies

FXP can be an effective tool for managing specific market risks and capitalizing on short-term opportunities. Below are a few strategies to consider when investing in FXP.

Hedging Strategy

Use FXP as a hedge if you have significant exposure to the Chinese market and are concerned about potential short-term declines. By integrating FXP into your portfolio, you can offset some of the losses from your long positions.

Short-term Trading

For active traders, FXP offers opportunities to profit from daily market movements. Given the leverage, even small declines in the FTSE China 50 Index can translate into substantial gains. However, this approach requires careful monitoring and quick decision-making.

Risk Management in Volatile Markets

In highly volatile markets, FXP can offer protection against sudden downturns. By allocating a small portion of your portfolio to FXP, you can achieve some level of downside protection. Remember, this approach should only be used in the short term due to the daily reset characteristic.

Conclusion

FXP offers unique advantages for hedging and short-term speculation but comes with high risks and costs. It's crucial to understand its structure and limitations before incorporating it into your investment strategy. For those who can manage the risks and costs, FXP can serve as a valuable tool in diverse and sophisticated investment portfolios. Always weigh the pros and cons, and consider your investment goals and risk tolerance before jumping into inverse leveraged ETFs like FXP.