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
- 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.
- 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.
- If the market falls, the ETF must pay the counterparty 2-for-1, in addition to the set cash payments already owed.
- 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.
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.
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