I found this abstract on leveraged ETFs:
Leveraged and inverse Exchange-Traded Funds (ETFs) have attracted significant assets lately. Unlike traditional ETFs, these funds have “leverage” explicitly embedded as part of their product design. While these funds are primarily used by short-term traders, they are gaining popularity with individual investors placing leveraged bets or hedging their portfolios. The structure of these funds, however, creates both intended and unintended characteristics that are not seen in traditional ETFs.
This note provides a unified framework to better understand the underlying dynamics of leveraged and inverse ETFs, their impact on market volatility and liquidity, unusual features of their product design, and questions of investor suitability. We show that the daily re-leveraging of these funds can exacerbate volatility towards the close. We also show that the gross return of a leveraged or inverse ETF has an embedded path-dependent option that under certain conditions can lead to value destruction for a buy-and-hold investor. The unsuitability of these products for longer-term investors is reinforced by the drag on returns from high transaction costs and tax inefficiency.
Just because leveraged ETFs are available does not mean you should use them. To me, they are designed for the sophisticated investor and generally not for Main Street.
Several readers have written in on the subject lately and complained about the lack of promised returns when using leveraged ETFs. My very limited experience confirms that. When testing my SimpleHedge concept during the past 1-1/2 years, I included some of these ETFs, namely SDS.
While SDS performed OK in general, I encountered periods where it did not give me the 200% performance I had expected, and which was necessary for the successful outcome of that particular hedge.
My view is that most investors should stay away from using these products and focus on an investment strategy where leverage is not a necessary ingredient. While maximizing returns is important, the increased risk in today’s volatile and uncertain market environment make using leveraged ETFs a questionable approach.
Comments 7
Ulli,
I used UOPIX during the strong market from mid 1999 thru early 2000, but unless you are experiencing an extremely euphoric up or down trend they will eventually bite you in most cases. Just like the video mentioned on the 1929 Crash that was the blog message yesterday, people that were on heavy margin were wiped out sometimes in minutes while others it took hours. Either way there are much too risky for me in this crazy market.
Ulli,
Does anyone have any stats as to what percentage of small investors make any money in the market by trading over any 5 year period.
Ulli,
I have always heard that most common folks who trade (dabble) in stocks do in fact lose even though they tell their friends how much they made on this or that, but fail to mention their losses. It is similar to your friends going to a casino, you ask how it went anf of course they won, yes and pigs can fly.
Anon,
I am well aquainted with a tax peparer and she says that most traders lose more than the make trading ETFs or Stocks. She says thinks they get caught up in the hype of the CNBC financial news guests and and people like Cramer with no trend timing consideration, only relying on ego alone. Hope this helps.
George,
Yes, you are absolutley correct.
Ulli…
Ulli,
Regarding common folks trading stocks and losing. How many traders do each of us know that are always talking about making money in the market trading stocks that live just a simple common life. Don't you think that if they really made any big money that they at least buy a new car once in a while and or a new home, but they don't. I would love to see there real track record for the last 10 years. I would have to say that they did worse than buying and holding all the S&P; 500 stocks.
I guess I'm a contrarian to the other people's comments about this article, in the blog. I think as long as you use stop sell, that leveraged ETFs work the same way that stocks or regular ETFs work. Of course, a lot of days they don't make the 200% or 300% they are trying to make, but, on the other hand, a lot of days they do or come pretty close.
I think it's important to know that, in general, stock brokers hate ETFs, for a lot of reasons. So, I don't take their advice about them. For one, they think they don't do anything for companies to generate capital to expand, but ETFs invest in companies, so I don't think they're "leaches" on the market, like a lot of stock brokers do.
I think sticking with stop loss, for leveraged ETFs and investors are just as safe as investing in any other equity.