In a steady bull market environment, with equities pushing toward new highs and volatility relatively subdued, leveraged ETFs have been outperforming their underlying triple leveraged or 3x strategies.
For example, the post-Trump, growth-oriented rally has fueled record gains in the technology segment, and more aggressive traders have capitalized on the advance through triple leveraged tech-related ETFs, such as the Direxion Daily Technology Bull 3X Shares (NYSEArca: TECL). TECL takes the leveraged 300% daily exposure of the Technology Select Sector Index, surged 95.6% year-to-date, or more than triple the 27.4% gain in the underlying benchmark.
Similarly, the semiconductor segment has been one of the best performing areas of the market, with the Direxion Daily Semiconductors Bull 3x Shares (NYSEArca: SOXL), which takes the leveraged 300% daily exposure of the PHLX Semiconductor Sector Index, jumping 136.6% year-to-date, compared to the 37.6% rise in the underlying index.
Additionally, the renewed interest in international equities, namely developing country exposure, has contributed to significant gains in emerging market equities, with more aggressive traders looking at the Direxion Daily Emerging Markets Bull 3X Shares (NYSEArca: EDC), which takes the leveraged 300% daily exposure of the MSCI Emerging Markets Index. Year-to-date, EDC increased 108.4%, compared to the underlying benchmark’s 31.3% gain.
Potential traders should keep in mind that these leveraged ETFs are designed to produce 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 funds do not perfectly reflect their intended strategies.
“Investors don’t realize that when there is a lot of compounding, their exposure is more than ‘3x,'” Andy O’Rourke, Managing Director and Chief Marketing Officer for Direxion, told ETF trends in a call.
A strong bull market without long interruptions and relative low volatility helped 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. In an upward-trending market, compounding can generate longer-term returns that are greater than the sum of the individual daily returns. Similarly, in a downward-trending market, compounding can generate longer-term returns that are less negative than the sum of the individual daily returns.
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However, leveraged ETF investors should not grow too complacent when holding on to these geared products for extended periods as a sudden risk-off even could abruptly whack investors on the downside or quickly erode the recent gains.
“Good leveraged ETF users will take some earnings off the table or even take all earnings off the table to rebalance their positions,” O’Rourke advised.
While trending markets may offer an opportunity to hold leveraged ETFs for longer periods of time to seek gains, users should still be aware of the risks involved with a highly leveraged position and consider trimming some of their recent gains to rebalance a leveraged position back to their initial weights.
For more information on geared products, visit our leveraged ETFs category.