Casting a Suspicious Eye

 | Apr 03, 2012 | 10:00 AM EDT  | Comments
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Stock quotes in this article:

GRPN

,

HDGE

As a consumer, I'm a huge fan of Groupon (GRPN). I'm stingy with my expenditures, and I have a hard time turning down a good bargain. So it's uncommon for a week to go by without my using at least one Groupon, which -- along with a growing roster of competitors -- has no shortage of too-good-to-be-true bargains.

As an investor, however, I'm not such a fan of Groupon stock. The competition is simply too intense, and the cost of acquiring new customers has grown too high. Moreover, I'm still not convinced that Groupon actually manages to add value for its clients. The concept of developing loyal customers doesn't seem to jibe with the reality of how consumers use the daily deal coupons.

So, when the company was gearing up for a high-profile initial public offering last year, I was far, far away. I was actually tempted to short Groupon stock once it started trading, but ultimately didn't have the stomach for the risk involved -- a decision I've come to regret. When the company got into hot water recently over some aggressive accounting treatments and was forced to restate results, I wasn't all that surprised.

This may seem to be a strange introduction to a column about ETFs, but there is indeed a pretty interesting connection. Groupon's latest misstep, which resulted in a significant decline in the stock price, is an excellent illustration of investment thesis behind the AdvisorShares Active Bear ETF (HDGE), an actively managed fund that utilizes forensic accounting principles in an attempt to identify stocks that are more likely to be on a collision course with unmet expectations.

In other words, HDGE screens for stocks that the managers suspect may be painting an overly bright picture of their operations -- using accounting conventions to mask the deterioration of a business. The nuts and bolts of the strategy are a bit complex, but the objective is simple: identifying the stocks that could have a rough patch ahead when the true nature of their operations is revealed.

Groupon proves there is something to this methodology. If you're able to identify companies that are being aggressive with their accounting practices before the rest of the market does (or before they 'fess up on their own), there can be a nice opportunity for profit. Groupon shares plunged shortly after news broke that the company would restate financials, as is often the case. So there's obvious value to having a short position in such stocks -- which is exactly what HDGE sets out to do.

There are, of course, some limitations to such a fund. HDGE is 100% short, which means it will generally get pummeled in bull markets. Also, there is no guaranteed way to identify the companies that are covering up a deteriorating business with accounting gymnastics. To be clear, HDGE isn't aiming to find companies that are cooking the books but, rather, those that are being aggressive within the limits of the law.

With that said, there are a couple of potentially interesting ways to use HDGE within a portfolio. Those who expect a rough patch ahead might find this ETF to be a handy tool for betting on a broad stock market decline. You could, for instance, utilize HDGE instead of an inverse ETF that offers short exposure to the broad market. The fund could also be coupled with a long ETF with the goal of generating alpha through a "market neutral" strategy. Or a small position in HDGE could be used as a partial stock market hedge in a longer-term portfolio, helping to smooth out overall volatility as a result of the strong negative correlation with traditional equity exposure.

Groupon's latest hijinks, therefore, serve as just further proof that there's an ETF for just about everything nowadays.

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