How Managing Risk With ETFs Can Backfire
Alcohol ads urge us to “drink responsibly.” Cigarette packs are emblazoned with the surgeon general’s warnings about cancer. And the firms that sell leveraged exchange-traded funds keep begging individual investors not to buy the things because they are meant only for short-term trading and can have erratic long-term returns.
Nonetheless, roughly 13,000 people are killed in alcohol-related crashes each year, over 33 million Americans smoke at least once a day — and more than $2 billion has poured into leveraged ETFs so far this year, much of it from financial advisers and retail investors who hang on too long.
ETFs are funds that trade during the day like stocks. A leveraged ETF seeks to use futures and other derivatives to multiply the daily return of a market index. Some, called “ultra,” “2X” or “3X bull,” attempt to double or triple the market’s return each day. Others try to double or triple the opposite of an index’s return; on a day when the market goes down, these “ultra-short,” “inverse 2X” or “3X bear” funds should go up two or three times as much.
So why bother with a boring index fund when you could double or triple your money by using a leveraged ETF? And why helplessly watch your stocks wither away when an inverse leveraged fund could let you mint money in a falling market?
There are 106 such funds with $46 billion in assets, much of it “hot money” that flies right back out. On Wednesday, trading volume for Direxion Financial Bear 3X totaled 23.1 million shares on only two million shares outstanding — implying an average holding period of less than 34 minutes.