talking point | the blog at LeeHudsonTeslik.com

More Caution on Leveraged ETFs

Posted in ETFs by teslik on November 4, 2009

I’ve written about this before, but I feel it bears  more coverage, and with one notable exception (Izabella Kaminska at the FT) nobody seems to be paying much attention. The ETF market strikes me as incredibly ripe right now for abuse (or confusion, at very least), given public interest in investments that seek leveraged or inverse returns, or both. There is a flood of new synthetic ETFs that might strike retail investors as logical vehicles through which to do this, but they are not what they seem at first blush.

Here’s an example. The following chart from Google Finance shows the S&P 500 index over the past year (the red line), and next to it the ProShares Short S&P500 index over the same period (blue).

etfchart

An investor buying such a product might logically assume that it would track the inverse of the S&P. You’ll notice in the chart that the S&P is up a little under 10% for these 12 months, so an investor might assume that the ProShares index mapping its inverse would be down roughly 10%. In fact, the ETF is down roughly 30%.

The discrepancy in returns comes, in large part, from how these sorts of ETFs work. Unlike buying a stock, which has a set value correlated to the value of a sliver of a company (i.e. it’s pegged to something that represents actual value, even if what that value is can be disputed), the NAV prices of ETFs are somewhat arbitrary. They “reset” after each trading day, and only seek to track their benchmarks for that day, not over the long-term.

Here’s what this means in practice. Say you buy one share of an ETF for $100/share. The ETF seeks to track the inverse of Stock Index A, which is trading at a NAV value of 100. On the first day, Stock Index A rises 10%, to 110. The ETF, assuming it tracks its daily benchmark perfectly, falls 10%, to $90/share.

Then, on day 2, Stock Index A gains another 10% (or 11 points — 10% of 110). The index closes the day at 121. The ETF, meanwhile, loses 10% of $90, or 9 points, and falls to $81/share.

Now, on the third day of trading, Stock Index A falls to 100. So it lost roughly 17.4% of its value. The ETF tracking the inverse gains the same percentage, or ~17.4%. But 17.4% of $81 is $14.06. So the ETF only rises to $95.06.

Result: The index winds up even after 3 turbulent days of trading. The ETF, however, has lost almost 5% over the same period.

The longer you hold a leveraged or inverse ETF, the more magnified this discrepancy becomes, even if the ETF is executing its daily objectives perfectly.

The key point here is that investors should be aware that these tools are not intended to map the inverse or leveraged returns of their benchmarks over long periods of time. This fact is easily lost on novice investors, particularly given that details about how ETFs actually work do not often play a prominent role in the advertisement of these products.

Advertisements

18 Responses

Subscribe to comments with RSS.

  1. […] More Caution on Leveraged ETFs […]

  2. taxloss said, on November 5, 2009 at 8:29 am

    Which is why Deutsche’s Short ETFs have “daily” in the title:

    http://www.dbxtrackers.co.uk/EN/showpage.asp?pageid=203

    Simple way of going about it!

  3. […] más criticas a los leveraged etfs By besanson Leave a Comment Categories: Trading Tags: ETF Continúan las  advertencias sobre la utilización de leveraged ETFs por parte de inversores poco sofisticados (ver nota) […]

  4. […] recuerdo, que en noviembre pasado, posteamos un link a una nota muy interesante sobre Leveraged […]

  5. Robby Senion said, on February 11, 2010 at 9:36 pm

    I am having issues seeing your website. It displays all weird with text displaying incorrectly. You might like to look at this.

  6. irvine Gold Mine said, on December 30, 2013 at 4:48 am

    Hey would you mind stating which blog platform you’re using?
    I’m planning tto start my own bloog soon but I’m having a difficult time
    making a decision between BlogEngine/Wordpress/B2evolution and Drupal.
    The reason I ask is because your design seems different then most blogs and I’m looking for something completely unique.

    P.S My apologies for getting off-topic but I had tto ask!

  7. hey there and thank you for your info – I have certainly picked
    up anything new from right here. I did however expertise several technical issues using this web site, since I experienced to reload the
    website a lot of times previous to I could get it to load properly.
    I had been wondering if your web host is OK? Not that I’m complaining, but slow loading instances times will sometimes affect
    your placement in google and can damage your high-quality score if advertising and marketing
    with Adwords. Well I am adding this RSS to my email and
    can look out for a lot more of your respective fascinating content.

    Make sure you update this again soon.

  8. You will now have an even better roadmap to
    CPA offers that many experienced affiliates
    probably wish they had when they started out — What are the different types of CPA offers.
    Contribute the maximum you can to 401(k) or other tax saving plans so that you get maximum tax exemption before the financial
    year ends. The bachelor’s degree in accounting includes about 36 credits of difficult accounting courses as well as another 20 credits in business courses.

  9. bodycon dress aliexpress complaints said, on August 25, 2014 at 8:52 am

    A diploma from fashion designing colleges is obviously
    your first class ticket to a career in fashion design. If you want to experience
    wearing dresses like most celebrities do, then you should constantly search for dresses on the internet.
    Women in India have turned back to traditional clothes like sarees with dark
    colors and attractive designs.

  10. laser hair therapy cost said, on August 31, 2014 at 7:21 am

    Much less pleasant but equally essential is understanding expertise these kinds of as cleansing dentures, feeding individuals, having temperatures and measuring catheter output, all of
    which totally get ready students for the expertise
    evaluation test. Electrolysis – Electrolysis is a solution which
    utilizes a needle to kill the hair at its root. We live in a climate
    that gets hot and humid and there are many activities to choose from.

  11. hair care products buy online said, on September 9, 2014 at 2:08 am

    Otherwise, hair may recede and erode further beyond your transplant, requiring
    additional surgeries in the future, because male pattern baldness is a progressive condition of hair loss over time.
    The Hair Regrowth Treatment makes easy or simple
    for everyone to get hair again. Both Iamin and Tricomin were invented and subsequently patented by Dr.

  12. biggest loser australia said, on September 13, 2014 at 2:39 pm

    Unapproved Medical Weight Loss Possibilities – Following are some unapproved weight loss
    possibilities which are being researched upon and may be
    available to the general public soon enough. The HCG Diet Protocol even works so well that we guarantee it with our Money-Back Guarantee
    Pack, which allows customers a risk-free opportunity to meet their weight loss goal.
    The time that it takes for you to take the HCG hormone
    is faster.

  13. celebrity dress up games online to play on said, on September 20, 2014 at 5:05 pm

    Yellow bridesmaid dresses are great for summer and spring weddings because they add flair and class
    to your wedding. It’s not just the black dress(4) that’s so wrong here – it
    is also the hair and makeup. For others this might be
    the time to highlight toned arms with a halter or strapless style, or nice legs through a tea-length dress.

  14. I also like that they are wrapped individually so I may open the
    package and take out what I need without worrying about re-wrapping the rest to prevent freezer burn.
    When tying the lines to your jugs use between 3′ and 6′ of line with a single hook attached.
    There are still unspoilt regions, but a lot of it is more like an open plan zoo that is not well maintained.

  15. dunnage board said, on September 25, 2014 at 4:25 am

    The idea of our homemade air conditioner with cool water is very simple.
    Fly Fishing Setup Tips – Fly fishing is a great way to
    catch more trout. There are so many great places to go while
    you are there.

  16. facial plastic surgeon wisconsin said, on September 27, 2014 at 3:05 am

    If you have any questions pertaining to where and ways to utilize
    web site ( super fast reply ), you can contact us at the web
    page. The rhinoplasty surgeons India enhance the nose by reshaping it by using
    components like cuboids, gristle (fibrous) and a couple of
    fashioned elements as well. You also need to think about the recovery process and the ways it might affect your daily life and work.

  17. myrtle beach area Marketing said, on October 3, 2014 at 10:25 am

    Working with a reliable marketing company can offer
    plenty of benefits. When executed properly, it can build your websites
    exposure, increase your traffic and improve your
    conversion rate. In all this, Press Release distribution service is great way to
    enhance your website’s visibility.

  18. boutique dress forms said, on October 3, 2014 at 11:35 pm

    Transparent hair color simply cannot compare to the intensity and dramatic appeal of opaque hair color.

    Colors reflect our moods so I guess that is why fashion matters to us.
    These steeply-priced shoes are demure, yet captivating.


Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: