This March, as the market stumbled over the Bear Stearns (BSC) collapse, ProShare Advisors posted a small notice on its Web site: "Bear Stearns is not a counterparty to any of the financial instruments held by ProShares." That's about the only information customers of the Bethesda (Md.) manager's most popular exchange-traded funds can get about what investment banks ProShares does business with, however. And it's these banks, or counterparties, that most "bear" funds rely on to take the other side of the complex financial deals that underlie their performance.After the string of nasty surprises in the markets, investors want to be reassured that a company on the other side of a deal will be around to hold up its end. But with some of these bear, or "inverse" funds, determining who those counterparties are is a big challenge.
Take ProShares, which, with parent company ProFunds, manages several inverse exchange-traded funds (ETFs) and mutual funds, which rise when markets fall. Assets in its short ETFs have rocketed from zero to $12 billion in under two years, and these ETFs are the most popular in terms of new sales this year.
To understand the possible consequences of a counterparty going bankrupt, consider how an inverse fund works. ProShares uses derivative contracts called swaps to get the inverse return of indexes such as the Standard & Poor's (MHP) 500-stock index. (A swap promises an exchange of returns between two financial institutions.) To bet against the Nasdaq 100 Index, for instance, a fund would enter into a swap agreement with a counterparty that agrees to pay it 1% for every 1% the Nasdaq falls. On the flip side, the money manager would pay 1% for every 1% rise.
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