A Gentler View of Leveraged ETFs

Leveraged exchange traded funds have not been strangers to controversy with some executives going so far as to imply these geared ETFs could lead to the demise of financial makets.

That assessment is long on hyperbole, but it underscores the negative light with which these volatile products are often viewed. However, recent research from the Federal Reserve Board notes that the steady stream of capital moving into and out of ETFs such as the ProShares UltraShort S&P500 ETF (NYSEArca: SDS), ProShares UltraPro Short QQQ ETF (NasdaqGM: SQQQ) and the Direxion Daily Small Cap Bull 3X Shares (NYSEArca: TNA) helps steady the funds while mitigating the potential for disaster that some have previously forecast.

“What the researchers are saying is that money tends to move out of leveraged funds on the days the funds move up significantly—mostly due to profit-taking—and money flows in after down days. Such movement helps keep the asset base steady, thus reducing the fund’s need to rebalance its leveraged exposure in the direction of the market, which is what can contribute to volatility,” reports Ari Weinberg for the Wall Street Journal.

Data indicate leveraged ETFs remain popular with investors, though the asset is still just a sliver of the overall ETF industry’s assets under management. In November 2014, there was $58 billion allocated to leveraged ETFs with “45% of AUM is held in short products with leverage factors ranging between -1x to -3x. 55% of AUM is held in long products with leverage factors ranging between +1.5x to +3x. The leverage factor with the most assets is +2x, with 36% of AUM,” according to Boost, a unit of WisdomTree (NasdaqGS: WETF).

With greater returns, traders are exposed to greater risks. These products are best suited for active, risk-tolerant traders, something that both ProShares and Direxion, the two largest issuers of leveraged of inverse and leveraged ETFs, do a good job of explaining to investors on their web sites. [10 Best Leveraged ETFs]

A frequent criticism of leveraged ETFs is that the funds deviate widely from the indexes they attempt to deliver double or triple the daily performances of on either the bullish or bearish sides, but some of the less volatile leveraged ETFs do decent jobs of stick to their performance objectives even over 30 days.

For example, over the 30-day period ending Feb. 6, 17 of Direxion’s bullish triple leveraged ETFs had a variance of 1.27% or less from three times the underlying indexes. Among the issuer’s bullish and bearish funds with the worst 30-day variances were the Direxion Daily Gold Miners Bear 3X Shares (NYSEArca: DUST), Direxion Daily Junior Gold Miners Index Bull 3x Shares (NYSEArca: JNUG), Direxion Daily Junior Gold Miners Index Bear 3X Shares (NYSEArca: JDST) and theDirexion Daily Russia Bull 3x Shares (NYSE: RUSL), according to Direxion data.

Not coincidentally, DUST, JDST, JNUG and RUSL are four of the six most volatile Direxion ETFs over the past 30 days. Investors seem to be acknowledging the cautionary tale of holding leveraged ETFs for extend periods.

“The median holding period for the 46 largest leveraged equity ETFs (more than $100 million in assets) is 9.5 days,” the Journal reports, citing ETF.com data.

Additionally, ProShares and Direxion are boosting their offerings of non-leveraged fare. Last week, Maryland-based ProShares launched the ProShares Russell 2000 Dividend Growers ETF (NYSEArca: SMDV) and the ProShares S&P MidCap 400 Dividend Aristocrats ETF (NYSEArca: REGL), two dividend growth ETFs that serve as follow-ups to the successful ProShares S&P 500 Aristocrats ETF (NYSEArca: NOBL). [ProShares Grows Dividend Growth Lineup]