Most Popular ArticlesOctober 13, 2009
Is the hubbub justified?
In a survey we conducted this summer at ETFtrends.com, the majority of our readers (62%) felt that the scrutiny of these funds was unjustified, while another 33% felt that the scrutiny was justified, but that they were appropriate for investors who understood them. The other 6% felt that they were not appropriate products for anyone.
There are a number of misconceptions about these ETFs. Much of it is inaccurate, confusing, and in some cases, wrong. A few points:
Misconception: Leveraged ETFs provide returns of 2x and 3x the annual return of the underlying index
Fact: This myth seems to be one of the biggest surrounding leveraged ETFs and one that may be at the root of much of the ongoing strife; it may simply be the result of poor marketing. The truth is no leveraged ETF or exchange-traded note (ETN) seeks to provide a multiple of the annual return of an underlying index.
Misconception: Leveraged ETFs increase overall portfolio risk
Fact: While many investors and advisors view leveraged ETFs as speculative and risky, if used properly they may actually lower a portfolio’s overall risk. Leveraged ETFs and ETNs do not just allow for leveraged exposure, but can also provide an opportunity to access single exposure at half the price. For example, rather than going with the PowerShares DB Commodity Long ETN (DPU), one could go double-long with the PowerShares DB Commodity Double Long ETN (DYY) and invest half of what they intended while still gaining roughly the same exposure to commodities.
Misconception: Leveraged ETFs are too readily available and the average investor will hurt themselves
Fact:Investors deserve to have options – the more, the better. Give investors some credit – they are a smart, educated, affluent bunch. It’s up to the investor to acquire the education and information they need to move forward. If one’s goal is to protect investors from making uneducated decisions, why not prohibit funds with excessive fees? Or funds that are not well-diversified?
Furthermore, the fund companies that issue leveraged ETFs readily admit that their funds aren’t for everyone. They are very open about the risks. As much as the fund companies want to make money, they also want their investors to be successful with their products.
Misconception:They are buy-and-hold investments
Fact: They’re not. But this isn’t exactly news – many leveraged ETF investors have been able to successfully hedge their portfolios for short periods. These ETF providers readily acknowledge that these types of funds are meant to hedge risk, and they not funds around which one should plan their retirement.
Misconception: Leveraged ETFs don’t work the way they are supposed to
Fact: Leveraged ETFs operate exactly as they should – they reset daily. Over a period of time, you’re going to see internal compounding that will affect the returns. This isn’t a flaw in the funds: this is a mathematical fact that is impossible to avoid. If you invested in a leveraged ETF over a period of months and the market went down 20%, a 2x short leveraged ETF wouldn’t go up exactly 40%.
FINRA and the SEC have said their piece. Inverse and leveraged ETFs are doing what they’re supposed to do. They’ve proved to be immensely popular, and the regulatory authorities should not impose limits or consider doing away with such innovative products that thousands of investors and financial advisors have used with success.
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