Exchange traded funds that utilize derivative financial tools to achieve their intended strategies have drawn greater scrutiny from regulators. However, the investment vehicles have been working as intended for more sophisticated investors whom understand the tools.
Analysis of their market activity illustrates that leveraged exchange-traded funds have been used properly since they were registered in 2006, serving their intended purpose for suitable investors. Leveraged and inverse ETFs utilize derivatives contracts to enhance daily index returns. For instance, most leveraged ETFs are designed to produce double or triple the performance of the underlying market on a daily basis while inverse options reflect the opposite moves to a benchmark. Suitable investors who understand the risks associated with daily leveraged investment results should be willing to actively monitor their investments. Many investors who have utilized leveraged or inverse strategies to hedge their portfolios have looked to Direxion or ProShares ETF options for magnified equity or bond exposure.
Trading activity in leveraged ETFs have been consistently high compared to other types of ETFs, which suggests that tactical short-term traders are often those who utilize the geared products. For instance, the popular ProShares UltraShort 20+ Year Treasury (NYSEArca: TBT), which has $2.7 billion in assets under management, has an average daily volume of 2.8 million shares, according to Morningstar data.
In the wake of the 2008 financial downturn and subsequent environment of heightened volatility, the Securities and Exchange Commission began reviewing derivatives usage in mutual funds, ETFs and other investment companies to determine whether additional safeguards are required. [Derivatives-Based ETFs Await SEC Decision]
While the SEC originally implemented a moratorium on exemptive relief requests for new leveraged ETFs and others that used derivatives, regulators partially lifted the moratorium on actively managed ETFs but left the ban on leveraged ETF requests. [SEC to Lift Freeze on Active ETFs That Use Derivatives]
As leveraged and inverse ETFs gain in popularity, or notoriety, the industry has stepped up education on the products, highlighting the fact that these leveraged vehicles reset on a daily basis and the compounding effects could cause the returns of ETFs for periods greater than a day to diverge from their intended daily objectives, especially during volatile market conditions. [Do You Know How Your Leveraged ETFs Work?]
The ETF industry’s aggressive educational outreach has been emphatic towards investor suitability – these funds are not suited for long-term, conservative investors who prefer a buy-and-hold approach. Leveraged products have been used properly since their inception, serving as effective financial tools for the individuals who understand these trading instruments and want to act on a short-term active view of the markets.