Exchange Traded Funds (ETFs) have long been a part of many an investment plan for investors across the world. As per iShares, ETFs now account for nearly $9 trillion in Asset Under Management (AUM) around the world as Q2 2023 ended.
The value inherent in ETFs has been plain to most investors for years now. For a small fee (usually defined in percentage terms as Total Expense Ratio or TER) charged by the ETF issuer, investors receive diversified coverage across a large number of instruments in line with a “theme”. For instance, an ETF built around the S&P 500 offers exposure to stocks of the 500 largest publicly-traded companies across sectors. Since an ETF typically “track” an index which is, in turn, governed by rules that determine the weightage of each security within the index, the ETF’s investment strategy is driven by a rules-based approach readily accessible by the investor – thus affording the investor a high level of transparency regarding the usage of the capital they provide to the issuer.
Now, given that an ETF tracks a “theme” that could be affected by macroeconomic or even specific events, the prospect of betting on the trajectory of the theme arises. Professional investors can employ “leveraged ETFs” to do this. As per the U.S. Securities and Exchange Commission (SEC), these “leveraged and inverse ETFs” are very different from traditional ETFs:
Leveraged ETFs deliver multiples of the daily performance of the benchmark they track. For example, a 2x (two times) leveraged ETF seeks to deliver double the daily performance of the benchmark.
Inverse ETFs (also called “short” funds) deliver the opposite of the daily performance of the benchmark they track.
Leveraged inverse ETFs (also known as “ultra short” funds) deliver a multiple of the inverse of the benchmark’s daily performance.
The key element for investors to bear in mind is that “leveraged and inverse” ETFs deliver multiples of the daily performance of the benchmark they’re tracking. These instruments are thus “reset” daily, which tends to create confusion among some investors. Let us consider a simple example to illustrate this.
Assume the benchmark has a price of $50 today (Day 0) while 2X Leveraged ETF tracking this benchmark has a price of $10. The next day (Day 1), the benchmark goes up by 3% to reach $51.50. The 2X Leveraged ETF delivers twice the performance to reach $10.60. The day after (Day 2), the benchmark goes up by another 2% to reach $52.53. The 2X Leveraged ETF now delivers twice the performance to reach $11.02.
Many investors will add 3% and 2% together to arrive at the conclusion that the benchmark has risen 5% over two days. This is incorrect: by virtue of daily compounding, the benchmark has actually risen by 5.06% over this period. Similarly, the 2X Leveraged ETF has risen by 10.24%. Upon dividing the rise in the 2X Leveraged ETF by that seen in the benchmark, it can be seen that a 2X Leveraged ETF has delivered 2.02 times the performance (and not 2 times) of the benchmark over two days! This is not a mistake: the issuer of the Leveraged ETF is obligated to deliver multiples of the daily performance of the benchmark. The benefit seen in net performance across two days is a result of daily compounding.
Of course, it bears noting that “excess performance” over multiple days isn’t always the norm. Readers can refer to a fuller explanation of how rebalancing and compounding works in a variety of market circumstances in an earlier article here.
A core tenet in the consideration of ETFs versus Leveraged ETFs can be stated thus: investing into an ETF is equivalent to holding a conviction in the performance of the “theme” or benchmark the ETF tracks. Buying the S&P 500 is equivalent to “buying” the conviction that markets will rise over time. Many jurisdictions, in fact, reward the holding of ETFs in (say) pension plans with favourable tax treatments. However, investing into Leveraged ETPs is equivalent to “betting” on performance of the “theme” or benchmark in a short time frame. In other words, ETFs tend to be strategic investments while Leveraged ETFs tend to be tactical. Virtually every jurisdiction that has Leveraged ETFs available to investors will carry the disclaimer that no Leveraged ETF should be held for more than a day. The ideal means of investment, as per regulators, is that investors should sell their Leveraged ETFs near the end of trading hours and go back in the next day, if they wish to. Of course, given that it is a suggestion and not a requirement, many investors simply continue to hold on to their position in Leveraged ETFs for a period greater than 1 day.
The “official” nature of Leveraged and Inverse ETFs also differ by jurisdiction. For instance, Leveraged and Inverse ETFs aren’t themselves necessarily or universally considered to be ETFs. To provide the “leverage factor », the issuer typically purchases the magnified exposure either via derivatives or futures contracts – thus making leveraged and inverse ETFs “debt instruments” as opposed to ETFs, which are considered to be “collective investment vehicles”. Another confusing trend lies in the naming conventions adopted by the industry. For instance, a leveraged/inverse instrument with a broad index as benchmark that is also tracked by many ETFs is generally called a “Leveraged/Inverse ETF” but this doesn’t mean that it is an ETF itself. An instrument magnifying the performance of a smaller set of securities (typically 10 distinct tickers) without a weighing methodology is typically termed an Exchange Traded Note (ETN) while an instrument with an even smaller set of tickers (or even one ticker) as the benchmark would be termed an Exchange Traded Product (ETP).
Regardless of the confusing nomenclature and the tactical nature of these instruments, the Leveraged & Inverse (L&I) market has been witnessing a steady growth. As of the end of June this year, it has been estimated that over 1,200 listed instruments hold over $125 billion in AUM globally.
It should also not be assumed that all L&I instruments track equity indices as benchmarks: about 15% of all AUM is held in instruments tracking commodities, fixed income and even active trading strategies as benchmarks.
Overall, be it “Leveraged & Inverse” ETFs, ETNs or ETPs, the landscape is a target-rich environment for professional investors with a penchant for actively managing their portfolio’s performance. Leverage Shares has issued about 10% of all leveraged/inverse instruments in the market today. Please click here to learn about our leveraged/inverse, non-leveraged and custom ETPs.
Violeta a rejoint Leverage Shares en septembre 2022. Elle est chargée de mener des analyses techniques et des recherches sur les actions et macroéconomiques, fournissant des informations importantes pour aider à façonner les stratégies d’investissement des clients.
Avant de rejoindre LS, Violeta a travaillé dans plusieurs sociétés d’investissement de premier plan en Australie, telles que Tollhurst et Morgans Financial, où elle a passé les 12 dernières années de sa carrière.
Violeta est une technicienne de marché certifiée de l’Australian Technical Analysts Association et est titulaire d’un diplôme d’études supérieures en finance appliquée et investissement de Kaplan Professional (FINSIA), Australie, où elle a été conférencière pendant plusieurs années.
Julian a étudié l’économie, la psychologie, la sociologie, la politique européenne et la linguistique. Il possède de l’expérience en matière de développement commercial et de marketing grâce à des entreprises qu’il a lui-même créées.
Pour Julian, Leverage Shares est une entreprise innovante dans le domaine de la finance et de la fintech, et il se réjouit toujours de partager les prochaines grandes avancées avec les investisseurs du Royaume-Uni et d’Europe.
Oktay a rejoint Leverage Shares fin 2019. Il est responsable de la croissance de l’activité à travers des relations clés et le développement de l’activité commerciale sur les marchés anglophones.
Il a rejoint LS après UniCredit, où il était responsable des relations avec les entreprises pour les multinationales. Il a également travaillé au sein de sociétés telles qu’IBM Bulgarie et DeGiro / FundShare dans le domaine de la finance d’entreprise et de l’administration de fonds.
Oktay est titulaire d’une licence en finance et comptabilité et d’un certificat d’études supérieures en entrepreneuriat du Babson College. Il est également détenteur de la certification CFA.
Sandeep a une longue expérience des marchés financiers. Il a débuté sa carrière en tant qu’ingénieur financier au sein d’un hedge fund basé à Chicago. Pendant huit ans, il a travaillé dans différents domaines et organisations, de la division Prime Services de Barclays Capital à l’équipe de recherche sur les indices du Nasdaq (plus récemment).
Sandeep est titulaire d’un master spécialisé en finance et d’un master en administration des affaires de I’Institut de technologie de Chicago.