While market volatility has increased along with the number of leveraged exchange traded funds available, the high-octane investment products aren’t responsible for the market’s dramatic twists and turns.
Leveraged ETF products use derivatives and swaps to mimic 200% or 300% of the price movements of an underlying benchmark. Critics say that the growing popularity of the ETFs is affecting price movements in the underlying holdings. However, the volatility of leveraged ETFs has shown to be greater than that of the underlying indices they try to reflect, writes Micahel Rawson, ETF analyst at Morningstar. [What Are ETFs? — Leverage Increases Risk]
Furthermore, leveraged and inverse ETF products combined hold around $32 billion in assets. In comparison, U.S.-listed ETFs have over $1 trillion in assets, while mutual funds hold around $10 trillion in assets. [Do Leveraged ETFs Really Exacerbate Volatility?]
Rawson points out that if leveraged and inverse ETFs amplified volatility, assets within the funds would rise or fall along with peaks and troughs in market volatility. However, leveraged and inverse fund assets have been relatively flat, moving between $30 billion and $36 billion, despite new product launches.
Leveraged products rebalance daily, which forces the funds to trade in the same direction as that of the market. For instance, during a market up day, long and short funds are required to buy, which may contribute to the overall market gains. However, investors also lever their positions in the fund’s inverse counterpart, which would help bring theeaffect of leveraged/inverse products on the markets back to zero, Rawson notes.
Academics have also found that there is little evidence to show derivatives or short selling could cause market volatility. On the contrary, some experts believe that derivatives and short selling may even correspond with lower volatility. [Nasdaq Exec Says Don’t Blame ETFs for Market Swings]
For more information on leveraged products, visit our leveraged ETFs category.
Max Chen contributed to this article.