If market volatility spikes back up and markets sell-off again, investors may consider hedging the potential risks through geared exchange traded funds that track leveraged and inverse strategies.
On the recent webcast, ETF Trading Strategies for Volatile Markets, Mike Eschmann, Managing Director and Co-Head of Capital Markets & Institutional Strategy Team for Direxion Investments, helped explain how investors may magnify and hedge returns on a daily basis with leveraged and inverse strategies. For instance, a bull funds may seek 3x or 300% the daily performance of a benchmark, whereas a bear fund may seek -3x or 300% of the inverse of the daily performance of a benchmark.
Additionally, due to compounding, the leveraged and inverse ETFs may diverge from their long-term intended strategies. A strong bull market without long interruptions and relative lack of volatility can help maintain positive gains in the leveraged ETF. Since the ETFs rebalance on a daily basis, the compounding effect benefits leveraged ETFs in a upward-trending market. However, in times of increased volatility, leveraged ETF returns can fall behind their intended 2x or 3x strategies.
Eschmann pointed to four factors that are contributing to current volatility in the marketplace: the Chinese A-Shares market, oil swings and its effect on the energy sector, a potential Federal Reserve rate hike ahead and ongoing concerns in Europe, notably from Russia and Greece.
For instance, during the Crimea and Ukraine hostilities, investors played the Russia trade through the Direxion Daily Russia Bear 3x Shares (NYSEArca: RUSS) to hedge the downside and the Direxion Daily Russia Bull 3x Shares (NYSEArca: RUSL) to capture a potential bounce when things settled. [As Bears Leave Russia ETF, Some get Bullish With Leverage]
During the recent China A-Shares plunge, the Direxion Daily CSI 300 China A Share Bear 1x Shares (NYSEArca: CHAD) has experienced tremendous interest as investors tried to capitalize off the plunge. Additionally, when traders though the Chinese selling was overdone, people utilized the Direxion 2x Daily CSI 300 China A Share ETF (NYSEArca: CHAU) to capture a rebound.
Jonathan Chatfield, Chief Portfolio Manager for Probabilities Fund Management, also mentioned that leveraged and inverse ETFs may help capture areas of interest in a tactical portfolio when political or event-driven decisions may affect a market over the short-term.
“For periods believed to have the highest probability of gains, leverage may be used to increase potential returns,” Chatfield said.
Biff Robillard, President of Bannerstone Capital Management, also argues that inverse Treasury bond ETFs, such as the Direxion Daily 20-Year Treasury Bear 3X (NYSEArca: TMV) and the Direxion 7-10 year Treasury Bear 3x (NYSEArca: TYO), could help hedge a long fixed-income investment portfolio against a turn in the Treasuries market if interest rates begin to rise.
Financial advisors who are interested in learning more about geared ETFs for managing risks can listen to the webcast here on demand.