A leveraged exchange-traded fund (ETF) is a financial instrument that offers the return of an underlying index multiplied by a given leverage factor. The fund usually uses borrowed money, futures, swaps, and other derivatives to amplify the daily price movements of the underlying index. Investing in these exchange-traded funds involves a high level of risk and may not be suitable for all investors. They can lose all of their money, as we have seen during the recent market selloffs of 2018 and 2020,
In February 2018, for example, a sudden and unexpected rise in market volatility resulted in short VIX ETFs to lose more than 90% of their value in a matter of days (some of which were forced to liquidate altogether due to losses incurred). Or take a look at what happened to oil ETFs during the COVID recession. The ProShares Ultra Bloomberg Crude Oil ETF (UCO), which doubles the exposure to crude oil prices, lost 98% of its value from January 2020 to April 2020 and needed to complete a 1:25 reverse split in order to merely stay alive. Even when volatility rises modestly, these leveraged funds can easily fall by 10-20% or more.
Another disadvantage of leveraged ETFs is that their return will not match that of the benchmark index with the leverage factor taken into account. In other words, if the underlying index goes up over time, investors will not get the return of the index times the leverage. The reason is that the mathematics of compounding prevents the funds from exactly replicating the underlying index.
Despite all of this, asset managers keep issuing more exotic ETFs. Recently, Leverage Shares issued an ETF that is designed to offer 5 times the daily return on the Nasdaq 100 index.
Leverage Shares, which could be considered the European version of Direxion, which offers dozens of leveraged and inverse exchange-traded products (among others, of course), brought an unprecedented product to the market this week – the Leverage Shares 5x Long US Tech 100 ETP. As the name suggests, it’s designed to offer 5 times the daily return on the Nasdaq 100 index. This product, which is an exchange-traded note and not an exchange-traded fund, will be linked to the Invesco QQQ Trust (QQQ). Read more.
So there must be a demand for this kind of financial instrument? Let us know what you think.