The exchange traded fund universe is constantly expanding and fund providers have crafted increasingly complex products. Leveraged ETFs have attracted some controversy, and potential investors should understand how these products work, including daily resetting and the impact of compounding returns.
The vast majority of of fund investors do not understand how leveraged products operate, says Felix Salmon for SeekingAlpha. Leveraged ETFs have readily accessible prospectus sheets that explain the strategy, but investors are still holding on to these funds for periods much longer than one day, the blogger says.
Salmon remarks that most investors are applying simple notions gleaned from stocks and applying them to leveraged ETFs. He states that investors are better off without leveraged ETFs since a margin account could serve the same purpose.
Nevertheless, leveraged/inverse ETFs do serve a purpose for intraday traders. 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 is designed to go down twice that amount, before fees and other costs. 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.
But if held for more than a day, the leverage may not line up exactly over longer periods, especially in volatile markets.