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Beware the leveraged ETF Add to ...



Leveraged exchange-traded funds are, in theory, an excellent way to harness that conviction you have about the future direction of a particular index. Some of these funds will reward investors with two-times or even three-times the daily moves of the underlying investment - so if the S&P 500 rises 1 per cent, you could gain 3 per cent. In theory.

In practice, these ETFs have received a lot of criticism recently because investors have realized that the actual returns, on a longer-term basis, don't come close to reflecting the moves of the underlying indexes. Birinyi Associates listed a number of fine examples on their web site.

The Ultra S&P 500 ProShares , which aims to give investors twice the daily performance of the S&P 500, has fallen 66 per cent since June 21, 2006. However, its opposite - the ETF that gives investors twice the inverse performance of the S&P 500 - has risen just 12 per cent. In other words, if you had made an astute bet against U.S. blue-chip stocks during one of the greatest equity meltdowns in history, your return wouldn't have beaten the dividend on a high-yielding tobacco stock.

Same goes for a bet on energy. The Ultra Oil & Gas ProShares , which aim to deliver twice the daily return of the Dow Jones oil and gas index, has fallen 67 per cent since Feb. 1, 2007. However, the inverse ETF (again: twice the inverse daily return of the index) has fallen 56 per cent. In other words, a bet for or against energy stocks has resulted in similarly dismal returns.

"When leveraged and inverse ETFs were first released they were touted as wonderful new innovations," Birinyi Associates said. "As they have developed, more and more investors have caught on to the fact that they don't perform as expected."

 

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