Tags: Leveraged | ETF | short | term

Institutional Investor: Leveraged ETFs Are Only for Day Traders

Thursday, 13 Sep 2012 09:34 AM

By Michael Kling

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Some exchange-traded funds (ETFs) are producing outsized returns — sometimes more than 100 percent over the past year.

For instance, Daily Retail Bull 3X Shares was up 110 percent, notes Institutional Investor, using figures from ETF Database. Ultra Nasdaq Biotechnology was up 102 percent, and the Ultra Pro QQQ and Daily Technology Bull 32 Shares were up 87 percent and 83 percent, respectively.

But should ordinary investors buy them? The short answer is probably not. Certainly not if they're traditional buy-and-hold investors. These products are leveraged ETFs, which are rebalanced daily and designed strictly for day traders. They are designed to use debt and derivatives to amplify short-term returns, according to Reuters.

Editor's Note: Unthinkable Haunts Investors: Evidence for Imminent 90% Stock Market Drop.  

"Don't get caught up in all of the glitz and blinking lights," Paul Justice of Morningstar told Institutional Investor, comparing winning in ETFs with winning on slot machines.

If their underlying index rises without volatility over a stretch of time, investors can get two or three times the index, experts tell Institutional Investor.

If you hold them more than a day in a volatile market, you can lose big even if the index the ETF follows gains.

Their performance over longer periods of time can differ significantly from their indexes, especially during volatile periods, and that volatility is impossible to predict.

The Securities and Exchange Commission and Financial Industry Regulatory Authority have long warned investors against buying leveraged ETFs.

"Long term, you need to be very cautious going into any of these products," says Dave Nadig of IndexUniverse, according to Institutional Investor. "The issuers themselves will tell you they're intended as short-term vehicles."

Investors sued ProShares, a provider of leveraged ETFs, saying they weren't informed of the risks, but the judge dismissed the case, saying the risks were clearly spelled out.

The suit also charged that ProShares knew in advance, through a mathematical formula, that investors could suffer large losses, according to Reuters. The New York judge called the allegation implausible.

Editor's Note: Unthinkable Haunts Investors: Evidence for Imminent 90% Stock Market Drop.

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