Some short-selling funds to gain from SEC curbs

By Muralikumar Anantharaman

BOSTON (Reuters) - U.S. securities regulators' moves to curb short selling of financial sector stocks may give a boost to a handful of exchange-traded funds (ETFs) that are shorting the financial sector and producing sizzling returns.

Funds such as the $2.1 billion UltraShort Financials Proshares, as well as the recently launched $11.8 million Short Financials Proshares and $9.5 million 2x S&P Select Sector Financials of Rydex Investments benefit when the financial sector is suffering.

Unlike some hedge funds and other investors who short stocks, these funds take short positions through derivatives such as swaps and options. With the regulators' move set to hamper investors' ability to freely short financial stocks, these funds may see more demand.

"For someone that was involved in short-selling financials previously, this may appear to be the last game in town," Jeff Tjornehoj, senior research analyst at Lipper Inc, said of the ETFs dedicated to shorting the financial sector.

The U.S. Securities and Exchange Commission (SEC) issued an emergency rule on Tuesday to limit certain types of short selling in major banks and financial firms such as Fannie Mae (FNM.N) and Freddie Mac (FRE.N).

Short sellers arrange to borrow shares they consider overvalued and sell them in hopes of making profit when the price drops.

The emergency rule would require a short seller to borrow the securities before executing the sale. It would also require the investor to deliver the securities on the settlement date.

The rule will go into effect on July 21 and last through July 29, although it could be extended to last up to 30 days. The SEC said it will consider rules to address short selling issues across the entire stock market.

"Just because the SEC has made this ruling, that doesn't change the underlying thesis the investor had on why they want to short the financial sector," said Paul Justice, ETF strategist at Morningstar.

"So whenever you have your first choice taken away, the next logical move is to search for alternatives," he said.

Returns have been staggering for these funds. UltraShort Financials returned 102.5 percent in 2008 through Tuesday and was the best performer among all U.S. funds, according to Lipper. Its assets have jumped since it was launched in January 2007 and have crossed $2 billion now.

"It's a very easy way to gain short exposure to the market without the inherent risks that come with shorting. That's why it has been so successful," said Matt Hougan, editor of IndexUniverse.com, an independent ETF and index funds research site.

The Short Financials fund has returned 13.98 percent and the Rydex fund 32.03 percent in July through Tuesday. Both funds were launched in June this year, according to Lipper.