May 21, 2009 at 1:00 pm by Tom Lydon
The popularity of leveraged or long-short exchange traded funds (ETFs) has indicated that investors love them, even at a time when capital is hard to come by.
Leveraged ETFs give investors a lot of benefits: they are affordable, transparent and liquid, and they can double or triple the movements within an index, meaning they can so this with the upside. The recent bear market has contributed to the explosive growth of these funds.
But let’s fact it, many investors simply do not understand these funds enough to be using them, and they can be dangerous. Even the providers of these ETFs are open on this front and are working to make sure investors totally understand how short and leveraged funds can be used.
Dan Burrows for SmartMoney reports that these ETFs need constant minding and evaluation, and are in no way meant for a buy-and-hold approach. A short or leveraged ETF requires vigilance because they must be rebalanced daily. When the market is volatile, with sustained swings in either direction, the leverage (and the effect of compounding) can make them diverge wildly from what the unwitting investor expects them to do.
Leveraged ETF providers make this clear in their advertising and prospectuses. And spokespeople from leveraged ETF managers firms like Direxion and Rydex have told us that financial professionals, not retail investors, are their focus.
Unfortunately, the average investor does not understand the math involved to know what the rebalance is doing to their capital, and they don’t know that since these funds rebalance daily, they need to rebalance almost daily, as well.
The bottom line is that these are good tools and have lots of advantages, but investors really need to understand them before diving in head first.
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