Long term decay in leveraged ETF’s has created a stir with investors and regulatory officials. See this post on FINRA. Daily volatility in the markets has eroded the ETF’s long term. We found this blogger’s analysis worth the read on decay. “With the popularity of ETF’s came these funds which use 200% and 300% leverage. Read more…
Stocks have enjoyed 35%+ gains from the March lows, but the market has been trading sideways ever since. Volume has dried up and investors will be looking for a direction in the markets. Technology has seemed to hold up strong during these turbulent times and will try to emerge as leaders. Read more…
Leveraged ETF’s are a growing phenomenon that investors can’t seem get enough of. There are many critics of these investing tools, as some investors use them as a gambling vehicle or don’t know what they are investing in. The gain in popularity of leveraged ETF’s has now sent them global. Europe has launched the first leveraged funds to follow their indexes. Read more…
Leveraged exchange-traded funds have been offering investors more and more bang for their buck. But while funds that triple daily returns recently became a hit, that doesn’t necessarily mean quadruple funds are on the way.
Since so-called leveraged and inverse ETFs appeared in 2006, the pattern has been clear. Investors like funds that offer the chance for bigger and bigger gains – despite the risk of bigger losses.
While the fund industry has so far responded by upping the ante, experts say even more extreme funds would face design hurdles, such as extra costs and problems tied to market volatility. Unless someone uses a new blueprint, current levels of leverage could be the limit.
“We have no plans to launch products with higher leverage points,” says Andy O’Rourke, marketing director at Direxion Funds, which created a stir last year by launching funds that multiply daily returns by three. “If you had four-times or five-times (leverage) it would make it more difficult to run the fund.”
Direxion’s chief rival, ProFunds Group, wouldn’t comment on product plans. Rydex Investments, a third firm that offers leveraged ETFs, said multiples of four or five are “not something were looking at.”
Investors’ preference for the high-proof stuff became clear early on. When ProFunds launched the first bear and bull ETFs three years ago, it offered two types that let investors bet against the market: “inverse” funds that rose 1% if the market fell 1% and “double inverse” funds that rose 2% in the same scenario. (All long funds were double.)
Almost immediately, the double-inverse proved a bigger hit than the simple inverse, collecting more assets and racking up larger trading volumes. ProFunds’ rival Direxion was able to capitalize on that preference last November by launching three-times funds, that have already pulled in nearly $4 billion from investors, according to data from the National Stock Exchange.
Hartmut Graf, head of the index team at the German stock exchange in Frankfurt, gave a fascinating talk on the performance of leveraged indices at yesterday’s “Investing in ETFs” conference.
Graf started his presentation by recalling the basic fact about these indices – that they do not track the “equivalent” multiple of the underlying index return if held over long periods. Why? Because the simple effect of compounding and rebalancing on a daily basis leads to significant tracking error.
There are several good explanations on the internet of how this occurs, but one of the first and best was given by Tristan Yates and Lye Kok, here.
Essentially, what is called the “constant leverage trap” forces the fund to buy high and sell low, a strategy that goes against common sense. The higher the volatility of the underlying market, the more likely that leveraged indices will lose ground, as well. Furthermore, there’s absolutely no way of telling, given a certain period return on the underlying index, what the leveraged, or leveraged index’s return will be. What these derivative indices actually produce as a return is path-dependent; how you get to the end point is more important than what start and end levels of the “base” index actually are.
Graf reminded the audience that the expected ultimate value of an index that maintains constant leverage through daily or monthly rebalancing is zero. And the higher the underlying market volatility, the sooner you eat up all your capital.
Essentially, holders of leveraged and leveraged index ETFs are the ultimate gamblers. While these funds can deliver outsize returns for investors who get their market timing right, they are still playing a form of Russian roulette.
FAS/FAZ Dealing With Billions of Dollars of Securities Sales from Members (FAS, FAZ, BBT, COF, PFG, WFC, USB)
The triple leverage ETF’s, the Direxion Financial Bull 3X Shares (NYSE: FAS) and Direxion Financial Bear 3X Shares (NYSE: FAZ), are perhaps the most volatile of all financial-stock ETF’s. This morning these two are getting to deal with a wave of secondary offerings and capital offerings from constituent member banks and financial firms. These ETF’s are reacting to major “raising cash” filings and offerings from BB&T Corp. (NYSE: BBT), Capital One Financial Corp. (NYSE: COF), Principal Financial Group Inc. (NYSE: PFG), Wells Fargo & Co. (NYSE: WFC), and US Bancorp (NYSE: USB)……
……..As a result of all of these financials lower on offerings and after seeing profit taking in other major financial firms, we have the Direxion Financial Bull 3X Shares (FAS) down 9.8% at $11.32 and the Direxion Financial Bear 3X Shares (FAZ) up 8.9% at $4.90 at 9:47 AM EST.
I am loving those crazy new triple-the-market ETFs they have in the United States.
Here in Canada, we have a series of exchange-traded funds that give you twice what the market does on the up or downside in a given day. You know the Americans – if double is good, triple is better. Enter the new Direxion family of 3x bull and bear ETFs.
I invested close to $100,000 (U.S.) in four 3x bull ETFs on Tuesday and a little more than 48 hours later I sold to lock in a profit of 9.3 per cent. Not bad, eh? Too bad it was all in a virtual world where both gains and losses are nothing more than fun and games.
We’re talking here about online stock-trading simulators, where you trade stocks with imaginary money and then monitor your results. These simulators are the best toys ever if you are:
A student of investing who wants to explore different ideas with zero risk of losing money;
A new do-it-yourself investor who wants to practise trading before getting into the real markets;
An aspiring hotshot trader who wants a low-stress way to test ideas and strategies, and to match wits with other investors.
Don’t confuse trading simulations with the online portfolio trackers that most financial websites offer. Whereas you input the stocks you own into a portfolio tracker like an accountant, with a simulator, you start by making actual trades. That means thinking about what type of order to place and whether you’ll buy on margin, which means you’ll borrow to pay part of the cost.
I set up my portfolio of 3x ETFs on Wall Street Survivor (wallstreetsurvivor.com), which claims to supply U.S. business schools with stock-trading simulations for MBA students to use. The website is designed to work just like an online brokerage account, and that’s exactly what it does (truth be told, it works better than some online brokers I’ve tried).
Trading leveraged ETFs comes with a significant amount of risk, especially if the market begins moving against you.
This is why advisers recommend using a stop loss order. Often referred to simply as a stop, it directs your brokerage to automatically sell a stock or ETF if it falls to a pre-determined level. This is intended to limit an investor’s loss on an investment.
There are essentially two kinds of stops:
- A hard stop that causes the stock to be sold if it hits a particular price.
- A trailing stop that causes a stock to be sold if it falls a particular percentage from the most recent high
With leveraged ETFs it can sometimes be tricky setting stops. An investor must evaluate the underlying index and translate that evaluation into an appropriate stop for the leveraged ETF. This is necessary because the price action of the ETF is totally dependent on the performance of the underlying index.
Some ETFs are leveraged 2X, such as the ProShares ETFs. Others are leveraged 3X like the Direxion ETFs. Moves in the underlying index will tend to be exaggerated in the leveraged ETF so it is very important to understand how the leveraged ETFs will react.
There is an awful lot of hate out there for leveraged ETFs. Microcap Speculator identified the Direxion 3X ETFs as “Wealth Destroyers.” Jim Cramer called the Ultrashort Financials ProShares (SKF) the “ETF of mass banking destruction.”
But the fact is that leveraged ETFs are nothing but a financial tool, which like any other, can be used either responsibly or recklessly.
The best known and most-criticized leveraged ETFs are Direxion’s Russell 1000 Financials Bullish 3X ETF (FAS) and Russell 1000 Financials Bearish 3X ETF (FAZ), which aim to return triple the daily return of the Russell 1000 Financials Index in either a positive or negative direction.
Investors who play with these are 100% aware that they are playing with fire and have nothing to complain about when they lose money with them.
If you’re not using a leveraged or inverse fund these days, your chances of owning a top-performing ETF is greatly reduced.
On the other hand, if you do own a leveraged or inverse ETF, that doesn’t guarantee a winning hand. In fact, it might ensure just the opposite.
With leverage, if your ETFs haven’t made any of the “best” lists lately, chances are you’re going to wind up a big-time loser.
In the world of highly charged ETFs that provide 200% or even 300% leverage of their underlying indexes, few performance numbers fall in between the cracks. It’s an all-or-nothing game.
For example, if you’d bought the Rydex Inverse 2x S&P 500 ETF (NYSE: RSW) one year ago today, you would’ve gained more than 40% by now. If you’d bought the ProShares Ultra S&P 500 ETF (NYSE: SSO) in that same period, you would’ve lost 60%-plus.
The only real pattern showing up since the onslaught of leveraged and inverse ETFs on the market is that leaders will more likely than not come from one of those two categories. Whether it’s one or the other is dependent, of course, on the particular cycle at the time.
So how can you hope to own a real ETF winner without juicing up your portfolio these days?
It’s easier than you think. And best of all, you really don’t need 2x or 3x ability to be a top performer. In fact, it’s probably counterproductive for most long-term investors to own a leveraged ETF.
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.