Over the past decade, Exchange Traded Funds (ETFs) have gained
tremendous popularity due to many advantages and flexibility that
they offer investors. Some of the factors point to tax efficiency
when compared to mutual funds, cost effectiveness and transparency
as well as entry and exit flexibility.
Clearly investors have embraced these factors as total ETF
industry assets currently stands at $1.3 trillion after 34% year on
year growth as of 30th September 2012 (as published by
the ETF Industry Association).
The beauty of these products is that they allow investors to
express their views about a particular asset class/economy/industry
in the most efficient and cost effective manner, without the
worries of a single company blowing up the return. Nevertheless,
with over 1,400 products available in the market today, investors
are more paralyzed by choice than anything (see Q3 ETF Asset
Report: Investors Back in the Market?).
At this point, knowing one’s investment objective, time horizon
and risk tolerance becomes top priority. At the same time,
knowledge about individual products that they are investing in and
their workings also become extremely important.
Most often investors fail to understand the inner workings of
certain products that they invest in (especially the complex ones)
and end up losing a great deal. For example, leveraged and inverse
ETFs can certainly be great money making avenues for day traders or
for a very short period of time. However, investors seeking to make
money from these instruments by employing a traditional
‘buy and hold’ strategy are seem likely to lose
over time (read Three Biggest Mistakes of ETF Investing).
Leveraged ETFs in Focus
Traditionally, leveraged funds provide 2x or 3x the return of
the benchmark performance. For example, a fund that provides 2x the
exposure will rise by 2% if the benchmark rises by 1%, however, the
flip side also holds true. If the index falls by 1%, the ETF will
lose 2%.
On the other hand an inverse leveraged ETF bets against the
positive movement of the underlying index, usually over a single
day. Basically most of these products rebalance at the end of every
session and are built to only give investors the corresponding
amount of leverage over a single trading period.
This works really well over a short period of time, where the
actual compounded positive returns of the fund exceed the standard
compounded returns of the index. However, during oscillating
markets marked with periods of high volatility, this phenomenon can
hurt the investor leading to larger losses than what some investors
might initially expect (read Leveraged and Inverse ETFs: Suitable
Only For Short Term Trading).
Therefore, in order for the investors to profit from these
highly complex instruments it is prudent for them to understand 1)
What actually is the product betting on?, 2) How does it plan to
achieve returns 2x/3X the index?, 3) How often does it trade on a
daily basis in order to ensure tight bid ask spreads?
This last factor, high trading volume which often leads to tight
bid ask spreads, is very important for investors seeking to achieve
the best price for their trade. For this reason, and given how
volatile the leveraged market can be, obtaining a good price can be
vital for overall returns.
In the light of the above statement, we have highlighted 10 of
the most popular (i.e. with maximum average daily volume) leveraged
ETFs that are available to investors.
The following table summarizes the key attributes that are
prudent for any investor to consider before investing in these
leveraged ETFs. While we have briefly described some of the key
attributes of each below the table:
Table 1
ETF
|
Total Assets
|
Average Daily Volume
|
Expense Ratio
|
Leverage Factor
|
Index/Underlying
|
TNA
|
$618.41 million
|
10.97 million
|
0.95%
|
3X
|
Russell 2000 Index
|
SSO
|
$1.57 billion
|
7.07 million
|
0.92%
|
2x
|
S&P 500 Index
|
FAS
|
$1.13 billion
|
5.97 million
|
0.95%
|
3x
|
Russell 1000 Financial Services Index
|
QLD
|
$608.19 million
|
3.72 million
|
0.95%
|
2x
|
NASDAQ 100 Index
|
UPRO
|
$311.91 million
|
2.32 million
|
0.95%
|
3X
|
S&P 500 Index
|
ERX
|
$255.05 million
|
1.55 million
|
0.95%
|
3X
|
Energy Select Sector Index
|
UWM
|
$693.30 million
|
1.55 million
|
0.98%
|
2x
|
Russell 2000 Index
|
AGQ
|
$980.26 million
|
1.48 million
|
0.95%
|
2x
|
Silver Bullion
|
DDM
|
$215.82 million
|
518,000
|
0.95%
|
2x
|
Dow Jones Industrial Average Index
|
UST
|
$19.81 million
|
476,000
|
0.95%
|
2X
|
Barclays Capital U.S. 7-10 Year Treasury Index
|
For investors seeking for a leveraged play on the broad market
via large cap basket we have highlighted four products. The
ProShares Ultra S&P500 ETF (SSO), ProShares Ultra QQQ ETF
(QLD), ProShares UltraPro S&P500 ETF (UPRO) and ProShares Ultra
Dow30 ETF (DDM) are some of the large cap leveraged ETF
which are most liquid.
As is evident from the table above, SSO and
UPRO both track the S&P 500 Index. The former
seeks investment results that correspond to twice the daily
returns of the index whereas the latter seeks to provide
3x the returns of the S&P 500.
Despite having different investment objectives, both of these
ETFs charge the same expense ratio of 95 basis points. Both these
ETFs use swap contracts to achieve the leverage that they strive
for.
It is also very important to note that both of these ETFs are
rebalanced at the end of day, therefore generally on intraday basis
the ETF returns will not be equal to stated objective of 2x or 3x
the index returns (see more in the Zacks ETF
Center).
Thankfully, the ETFs provide the cushion of high traded volume
and a substantial amount of popularity. SSO has an asset base of
$1.57 billion coupled with an average daily volume of 7.07 million
shares. On the other hand, UPRO has attracted $311.91 million in
its asset base with an average daily volume of 2.32 million
shares.
The ProShares Ultra Dow30 ETF
(DDM) is the appropriate
choice for investors seeking for a leveraged play on the Dow Jones
Industrial Average Index. The Dow is by far one of the oldest stock
indexes in the world. Its components are price weighted and it
consists of only 30 large cap stocks (read Inside the Dow Jones
Industrial Average ETF (DIA)).
The ETF has been able to amass $214.96 million in its asset base
since its inception back in June of 2006. DDM is rebalanced on a
daily basis and provides exposure of 2x the daily returns of the
Dow Jones Industrial Average Index. It uses a variety of Index
swaps to achieve its stated leverage.
The ETF has an average daily volume of about 518,000 shares and
charges 95 basis points in fees and expenses.
Launched in June of 2006, the ProShares Ultra QQQ ETF
(QLD) seeks to provide
2x the daily returns of the Nasdaq100 Index. The NASDAQ 100 index
includes the largest non financial companies from the U.S. as well
as abroad.
The ETF has a fairly large asset base of $608.19 million and
charges 0.95% as expense ratio. The ETF enters into swap contracts
with different financial institutions to provide the leveraged
exposure. QLD also has a very high average daily volume of around
3.72 million shares (see The Apple Effect and Nasdaq ETFs).
Having discussed some of the large cap leveraged ETFs, let’s now
focus on a couple of small cap ones.
The Direxion Daily Small Cap Bull 3X Shares
(TNA) and
ProShares Ultra Russell2000
(UWM) are two ETFs which
provide leveraged play on the Russell 2000 index.
The Index measures the performance of the small cap segment of
the U.S. equity markets and is a subset of the Russell 3000 index.
The benchmark is composed of 2000 stocks which make up roughly 10%
of the total market capitalization of the Russell 3000 index.
TNA provides 3x leveraged exposure whereas UWM provides twice
the daily returns of the Russell 2000 index. With an average daily
volume within striking distance of 11 million shares, TNA is by far
the most heavily traded leveraged ETF available in the market. The
ETF also exhibits popularity as indicated by its asset base of
$618.41 million (see Three Small Cap ETFs with Impressive
Yields).
On the other hand, UWM also enjoys a high average daily volume
of more than a million shares and has been able to amass around
$694 million since its inception in January of 2007.
Also, both of these ETFs utilize index swaps to provide the
stated leverage. TNA charges an expense ratio of 95 basis points;
however, UWM is slightly more expensive than TNA charging
0.98%.
The financial sector has been one of the top performing sectors
this year. It has been pretty much leading the market rally so far
this year after a disastrous performance last fiscal year.
The Direxion Daily Financial Bull 3X Shares
(FAS) is an ETF that
provides a leveraged play on the financial sector. It seeks
investment returns that correspond to 3x the daily returns of the
Russell 1000 Financial Services Index.
The index includes stocks of financial services companies from
the entire spectrum of market capitalization (read Inside The Top
Zacks Ranked Financial ETF). With an asset base of $1.13 billion,
FAS is one of the most popular leveraged financial equity ETFs. It
charges investors 0.95% as expenses, and on an average does about
5.97 million shares daily.
The Direxion Daily Energy Bull 3X Shares
(ERX) provides a
leveraged exposure on the energy sector. It strives for 3x the
daily returns of the Energy Select Sector Index, which measures the
performance of companies from the oil and gas, consumable fuels,
oil and gas equipments and services etc.
ERX aims for the leverage by entering into index swap contracts
with different financial institutions. It charges an expense ratio
of 95 basis points and does about 1.55 million shares daily in
volume. It has an asset base of $255.05 million (read Uncertain
about the Economy? Try Market Neutral ETFs).
The ProShares Ultra Silver ETF
(AGQ) seeks 2x the daily
returns of silver bullions which are U.S Dollar denominated for
London delivery. This means that along with the volatility in the
individual commodity price, the ETF will also be subject to
currency exchange rate between the U.S Dollars and the Pound
Sterling.
Obviously being a leveraged ETF the fund takes long
positions derivative instrument like silver futures and enters into
silver forward contracts with different financial institutions to
gain leverage on the underlying asset class (i.e. silver
bullion).
The ETF is also rebalanced daily and charges investors 95 basis
points in fees and expenses. AGQ has a fairly large asset base of
$980.26 million and an average daily volume of about 1.48 million
shares.
ProShares Ultra 7-10 Year Treasury
(UST) is a daily
rebalanced leveraged long ETF which is designed to generate 2x the
daily returns of the Barclays Capital U.S. 7-10 Year Treasury
Index. The index measures the performance of intermediate term
Treasury bonds which have a residual maturity ranging from 7 to 10
years.
Most fixed income ETFs, especially long dated Treasury bonds,
have seen tremendous rally in the recent past mainly thanks to the
risk aversion of investors fuelled by the Eurozone debt crisis and
concerns over global economic slowdown. The Federal Reserve’s ultra
low interest rate policy is also responsible for attracting
investor appetite towards these instruments.
However, from the third quarter onwards, investors have started
to show interest in the ETFs from riskier asset classes and high
yield bond ETFs for higher current income thereby reducing the
demand for the lower yielding Treasury bonds.
This has caused massive asset outflows from the Treasury Bond
ETFs and negatively impacted the intermediate and longer dated
Treasury Bond ETFs within this time frame (read Long Term Treasury
ETFs: Ultimate QE3 Play?).
Nevertheless, this seems to be a short term phenomenon as it is
quite evident from the Fed’s actions (such as Operation Twist) that
the low interest rate scenario, especially in the Treasury bond
front, is most likely to remain for quite some time.
Investors could go for a magnified exposure to the 7 – 10 year
Treasury bond segment should consider UST for short term trades.
The product has around $20 million in its asset base and on an
average does a good daily volume of around 476,000 shares. It
charges an expense ratio of 95 basis points.
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PRO-ULT SILVER (AGQ): ETF Research Reports
PRO-ULTR DOW30 (DDM): ETF Research Reports
DIR-EGY BULL 3X (ERX): ETF Research Reports
DIR-FIN BULL 3X (FAS): ETF Research Reports
PRO-ULTR QQQ (QLD): ETF Research Reports
PRO-ULTR S&P500 (SSO): ETF Research Reports
DIRX-SC BULL 3X (TNA): ETF Research Reports
PRO-ULT S&P500 (UPRO): ETF Research Reports
PRO-ULT 7-10 YT (UST): ETF Research Reports
PRO-ULTR R2000 (UWM): ETF Research Reports
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