Hi
You may remember, that I was talking about short ETFs a few pages back. To complete the subject, here some very important information, which you really have to consider, in case any body wants to invest in leverage ETFs. Read the last two parts very carefully to understand, how to use this leveraged products. The post is a mix from different articles I put together. Source is ETFdb, which has the biggest data base from ETFs in the States.
Over the last year, inverse and leveraged funds have exploded onto the scene, attracting massive amounts of assets from sophisticated investors who had seen many of their traditional channels for obtaining leverage shrink or close altogether as a result of the credit crunch. “Amid the turmoil of the last year, one constant has been the growth in inverse and leveraged products,” notes John Cronin, an ETF product strategist for State Street.
While the retail base for leveraged ETFs is shrinking rapidly, don’t put any stock in reports that this is the beginning of the end for these products. As I’ve said countless times, leveraged funds aren’t a good match for advisers at these firms who don’t have the time to monitor client accounts on a daily basis. Since these announcements have hit, trading volumes on the most popular leveraged exchange-traded products haven’t seen any discernible drop. I’m not saying that no one at these firms was ever using leveraged ETFs, but the number pales in comparison to the group of sophisticated that thoroughly understands these products and will continue to use them. Users of leveraged ETFs have a tremendously high risk tolerance, and the time and resources to move rapidly in and out of positions in these funds.
Many of these funds promise to deliver twice the return of an underlying stock or bond index -- or move twice as much in the opposite direction. So with the Standard & Poor's 500-stock index down 38.5% in 2008, a double-leveraged fund designed to profit when the S&P 500 falls would be up 77%, right?
Wrong. The UltraShort S&P500 ProShares rose 61%. Even more confusing, the ProShares fund designed to return twice the opposite of the Dow Jones U.S. Real Estate Index was down 50% for 2008, while the index was also down, by 43%.
The issue is that these funds are designed to double the index's return -- or double the inverse of that return -- on a daily basis. The compounding of those daily moves can result in longer-term returns that have a very different relationship to the longer-term returns of the underlying index.
For example, take a double-leveraged fund with a net asset value of $100. It tracks an index that starts at 100 and that goes up 5% one day and then falls 10% the next day. Over that two-day period, the index falls 5.5% (climbing to 105, and then falling to 94.5). While an investor might expect the fund to fall by twice as much, or 11%, over that two-day period, it actually falls further -- 12%.
Here's why: On the first day, doubling the index's 5% gain pushes the fund's NAV to $110. Then, the next day, when the index falls 10%, the fund NAV drops 20%, to $88.
For the most part, these funds are used by short-term traders. But they're gaining traction among individual investors who use them as a hedge in a portfolio. That's where these distortions cause real trouble.
“Short-Term Investments For Long-Term Goals” ?
Despite the fact that they are designed for short-term, sophisticated traders, 3x ETFs are becoming increasingly popular among individual investors who see them as long-term performance enhancers or hedging instruments. While leveraged ETFs offer an opportunity to enhance intra-day returns, anyone holding these funds for more than a day may be disappointed with the results.
To their credit, ProShares and Direxion provide ample warnings about the discrepancies between daily and long-term returns in their marketing materials, and have actively discouraged long-term investors from utilizing their products. Leveraged ETFs may provide a short term burst, but will burn out over the long run, exposing buy-and-hold investors to undesirable levels of risk. As Direxion’s marketing chief Andy O’Rourke quipped, holding a leveraged ETF for longer than a day is “like using a toaster to cook a turkey.”
Take care
DanPickUp
