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(Yong Hian Lim/Getty Images/iStockphoto)
(Yong Hian Lim/Getty Images/iStockphoto)

Leveraged ETFs

Understanding leveraged ETFs Add to ...

Leveraged ETFs are highly speculative short-term investments. ​They aim to double or triple the daily return of a market index. Sometimes they are designed to move opposite to the market. Your ability to make money largely depends on whether you correctly guess the short-term direction of the market.

You will likely lose money if you hold a leveraged ETF for longer than a few days. For this reason, leveraged ETFs are not appropriate for investors who are planning to hold their investments for longer than a few days.

How it works

  1. To double the daily return of a market index, the ETF will borrow – or leverage – other assets. The ETF never actually owns these assets. Instead, it uses a complex form of financing involving “swaps". The ETF makes a deal – or swap – with a counterparty that does own the assets (for example, a bank or investment firm). The counterparty “lends” the assets to the leveraged ETF, in return for set cash payments.
  2. In a long swap, the counterparty agrees to pay the ETF $2 for every $1 rise in the closing value of a market index that day.
  3. If the market falls, the ETF must pay the counterparty 2-for-1, in addition to the set cash payments already owed.
  4. There are limits to how much the ETF can borrow at any time. The ETF must rebalance — or “releverage” — its position every day. This is necessary to keep the amounts borrowed in line with the actual stock owned.

Example – A leveraged ETF with $200 million in net assets aims to double the daily return of a certain market index. To do this, the ETF needs to borrow — or leverage — another $100 million worth of assets.

Comparing fees

As with all ETFs, you'll usually pay a commission each time you buy or sell a fund.

The management expense ratio (MER) of a leveraged ETF tends to be about 1.15%. This is:

  • higher than index ETFs, which usually have MERs of less than 0.5%, but
  • lower than actively managed mutual funds, which can run to more than 3%.

Sam and Sasha invest in leveraged oil ETFs:
With oil prices at record highs, 2 brothers — Sam and Sasha — sense an investment opportunity. Where will prices move next? Read Sam and Sasha's story.

Content in this section is provided in partnership with Investor Education Fund, a non-profit organization founded and supported by the Ontario Securities Commission that provides unbiased and independent financial tools to help Canadians make better money decisions. To find out more, go to: GetSmarterAboutMoney.ca

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