Leveraged and inverse exchange traded funds (ETFs) can be a boon or a bust, depending on an investor’s knowledge and skill in using the unique investment tool. Most people trade with this type of ETF in a short bursts, but there is a way to use this tool in a long-term strategy.
In a study conducted on leveraged and inverse fund investments in the S&P 500, it is shown that that there is a high probability of approximating one-day targets for periods longer than a trading, write Joanne Hill and George Foster for IndexUniverse.
Leveraged and inverse ETFs were made to reflect a multiple, be it positive or negative, of a benchmark’s returns on a daily basis. For periods greater than a day, returns can be higher or lower than the one-day target multiple times the benchmark, which is the effect of compounding. This effect is heightened during a volatile market.
On average, the impact of compounding is practically neutral for most broad indexes. The effects of leveraged and inverse strategies are likely to equally benefit or hurt as a result of compounding for up to 30 days in the S&P 500.