Investors can use leveraged and inverse exchange traded funds to hedge a long position against sudden turns or capture short-term trends in more volatile market conditions.
On the recent webcast, Tactical Strategies to Combat Market Volatility, Sylvia Jablonski, Managing Director and Co-Head of the Capital Markets & Institutional Strategy Team at Direxion, points out that the markets have exhibited heightened volatility, so securities are experiencing wider swings.
“We are witnessing a volatility regime change,” Jablonski said. “Average intra-year volatility has climbed to new highs.”
Michael Venuto, Co-founder & CIO of Toroso Investments, also argues that we can no longer rely on factors like quantitative easing to support a consistent market rally with limited volatility.
“The market has been irrational the last few years,” Venuto said. “Expect a return to normal volatility.”
Consequently, with the heightened volatility, more investors are beginning to pick up leveraged and inverse ETFs to play the market swings.
Jablonski explained that these leveraged and inverse ETFs try to magnify the returns of their benchmarks on a daily basis. Investors should keep in mind that most leveraged ETFs are designed to produce double or triple the performance of the underlying market on a daily basis. Consequently, when investors look at the long-term performance of a typical leveraged ETF, people may notice that the fund may not perfectly reflect their intended strategies.
A market without long interruptions and relative lack of volatility will help maintain positive gains in a leveraged ETF. Since the ETFs rebalance on a daily basis, compounding effects benefit leveraged ETFs in a consistently trending market. On the other hand, in times of increased volatility, leveraged ETF returns can fall behind their intended 2x or 3x strategies.
“Historically, the best environment for the use of leverage has been low volatility high trend,” Venuto said.