[This article appears in our January 2017 issue of ETF Report.]
ETFs let investors express a vast number of viewpoints—including if an investor expects prices to fall, or wants to magnify a return.
Leveraged ETFs allow investors to take a chance to enhance the risk they’re taking on a daily basis, says Todd Rosenbluth, director of ETF and mutual fund research for CFRA. These funds often are designed to have returns two or three times their benchmark on a daily basis. Meanwhile, inverse ETFs allow investors to easily short an index if they believe the price will fall.
But the vehicles used to place these trades—leveraged and inverse ETFs—often have poor returns.
“They’re intended to move more aggressively than the broader market that they’re representing. If the trend flips, you can get hurt very quickly. You can make money very quickly, and it’s usually the getting hurt very quickly that investors tend to not see coming,” Rosenbluth said.
Daily Resets Erode Returns
The problem investors run into with these funds occurs when people hold them for more than a day or two, say Rosenbluth and Brett Manning, senior market analyst at Briefing.com.
Because they reset daily, arithmetic works against buy-and-hold investors, Manning says.
Manning used a hypothetical example to explain the long-term drag for leveraged performance. If an index on Monday is at 10, on Tuesday rises to 11 and on Wednesday falls back to 10, a double-leverage long ETF would rise to 12, but then fall to 9.82. It rose 20% on Tuesday, but fell 20% on Wednesday. Because a 20% drop from the higher number leads to a larger nominal decline, the investor loses money.
