“I have long warned investors about the potential dangers of leveraged and inverse leveraged funds. These funds typically use financial derivatives such as options and futures to leverage the fund to increase the return (or inverse of the return) of the underlying index and give fund performance a boost. It wasn’t long before triple-leveraged funds became available, offering investors three times the daily return of the tracked index. While this may sound like a sure way to make a few extra bucks on the market’s movement, such funds are frequently more dangerous than investors realize. Apparently, Morningstar is starting to see these funds in much the same light. They recently announced that they were considering moving inverse and leveraged funds from their current broad fund categories and placing them in a separate group. With this move, they would also no longer rank these funds on the one- to five-star rating system currently used for other mutual funds. Morningstar indicated that these funds were closer to being “trading vehicles” rather than investment vehicles, which is what their star rating system is meant for,” Amanda B. Kish Reports From The Motley Fool.
Kish goes on to say, “Furthermore, because leveraged funds typically track the daily return of their intended indices and not the annual return, returns can be far worse than investors expect under certain situations. For example, Direxion Daily Financial Bear 3X Shares (NYSE: FAZ), which offers 300% of the inverse of the Russell 1000 Financial Services Index, was launched in November 2008 and since that time has lost a stunning 97.1% on a cumulative basis, despite the index only rising about 18% over that period. Unfortunately, in light of the stock market’s recent troubles and investors’ general attitude of risk avoidance, people are now more inclined to consider funds like these. Some of the most popular inverse and leveraged funds include ProShares Short S&P 500 (NYSE:SH) and the ProShares UltraShort S&P 500 (NYSE:SDS), which are inverse and double-leveraged inverse funds with $2.7 billion and $3.9 billion in net assets, respectively. The ProShares UltraShort QQQ (NYSE:QID), which provides double the inverse of the return of the Nasdaq 100 Index, boasts nearly $1.1 billion in assets. The largest such fund, however, is the ProShares UltraShort 20+ Year Treasury (NYSE:TBT), with more than $4.2 billion in assets. All of these funds have been around less than five years.”
“If you’ve been tempted by the outsized returns some of these funds have put up lately, like the double-leveraged ProShares Ultra Gold Fund (NYSE: UGL), which has gained 61.3% in the past year, take a minute before rushing to buy. Funds like these really are more suited to short-term gambling rather than long-term investing. There’s a good reason why Morningstar may be discontinuing its star ranking among this group of funds; they simply don’t serve the same purpose as other ETFs or actively managed funds. If you’re an ETF investor, stick to the tried and true. Invest in simple, low-cost funds that give you no-frills exposure to a wide swath of the market. It may not be as exciting as buying a fund that offers three times the daily return of the Brazilian stock market, but you also aren’t likely to end up out of luck and out of money when the market moves against you,” Kish Reports.
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