With the recent uncertainty in the markets due to natural disasters and geopolitical events, some may be looking at alternative ways to invest with their exchange traded funds (ETFs).
Leveraged and inverse ETFs are funds that aim to magnify the daily moves of the market. In a short double-leveraged fund, if the index goes up, then the fund goes down twice that amount. In a long leveraged fund, if the index goes up, the fund doubles that. The same principle applies when you’re talking about triple-leveraged ETFs, too.
Most leveraged and inverse ETFs have an objective to provide a daily multiple, for instance, plus or minus 200%. The funds have a daily target to limit risk of having too much leverage or of losing more than what’s in the fund.
These funds can be appealing to investors as a hedge against any potential losses. Say you have a holding but don’t really want to sell it and you think the market is due for a short-term correction, then a leveraged or inverse ETF can be used as a hedge.
They can also be used to capitalize on market movements. If an investor believes the market is due for a nice run, a leveraged ETF could be used to maximize on this movement.
Before investing in these types of ETFs, investors should understand them and know the risks. They aren’t like your typical ETF. These ETFs reset daily and generally track their indexes. However, with the daily reset, compounding comes into play and an investor may see a fund drift from its benchmark. The ETFs seek to provide a multiple of the daily, weekly or monthly return of an index and are unlikely to provide returns that match these multiples beyond the ETFs respective time frame.
These ETFs do what they say they do, investors just need to make sure they understand how they work and how they might fit into their portfolio strategy.
Using the ETF Analyzer, you can search for the different inverse and leveraged funds offered by providers including ProShares, Direxion, Rydex and FactorShares.
For more information on leveraged and inverse ETFs, you can read more in our long-short ETFs category.