Over the past decade, Exchange Traded Funds (ETFs) have gained
tremendous popularity due to many advantages and flexibility that
they offer investors. Some of the factors point to tax efficiency
when compared to mutual funds, cost effectiveness and
transparency as well as entry and exit flexibility.
Clearly investors have embraced these factors as total ETF
industry assets currently stands at $1.3 trillion after 34% year
on year growth as of 30
th
September 2012 (as published by the
ETF Industry
Association
).
The beauty of these products is that they allow investors to
express their views about a particular asset
class/economy/industry in the most efficient and cost effective
manner, without the worries of a single company blowing up the
return. Nevertheless, with over 1,400 products available in the
market today, investors are more paralyzed by choice than
anything (see
Q3 ETF Asset Report: Investors Back in the
Market?
).
At this point, knowing one's investment objective, time
horizon and risk tolerance becomes top priority. At the same
time, knowledge about individual products that they are investing
in and their workings also become extremely important.
Most often investors fail to understand the inner workings of
certain products that they invest in (especially the complex
ones) and end up losing a great deal. For example, leveraged and
inverse ETFs can certainly be great money making avenues for day
traders or for a very short period of time. However, investors
seeking to make money from these instruments by employing a
traditional
'buy and hold'
strategy are seem likely to lose over time (read
Three Biggest Mistakes of ETF Investing
).
Leveraged ETFs in Focus
Traditionally, leveraged funds provide 2x or 3x the return of
the benchmark performance. For example, a fund that provides 2x
the exposure will rise by 2% if the benchmark rises by 1%,
however, the flip side also holds true. If the index falls by 1%,
the ETF will lose 2%.
On the other hand an inverse leveraged ETF bets against the
positive movement of the underlying index, usually over a single
day. Basically most of these products rebalance at the end of
every session and are built to only give investors the
corresponding amount of leverage over a single trading
period.
This works really well over a short period of time, where the
actual compounded positive returns of the fund exceed the
standard compounded returns of the index. However, during
oscillating markets marked with periods of high volatility, this
phenomenon can hurt the investor leading to larger losses than
what some investors might initially expect (read
Leveraged and Inverse ETFs: Suitable Only For
Short Term Trading
).
Therefore, in order for the investors to profit from these
highly complex instruments it is prudent for them to understand
1) What actually is the product betting on?, 2) How does it plan
to achieve returns 2x/3X the index?, 3) How often does it trade
on a daily basis in order to ensure tight bid ask spreads?
This last factor, high trading volume which often leads to
tight bid ask spreads, is very important for investors seeking to
achieve the best price for their trade. For this reason, and
given how volatile the leveraged market can be, obtaining a good
price can be vital for overall returns.
In the light of the above statement, we have highlighted 10 of
the most popular (i.e. with maximum average daily volume)
leveraged ETFs that are available to investors.
The following table summarizes the key attributes that are
prudent for any investor to consider before investing in these
leveraged ETFs. While we have briefly described some of the key
attributes of each below the table:
Table 1
|
ETF
|
Total Assets
|
Average Daily Volume
|
Expense Ratio
|
Leverage Factor
|
Index/Underlying
|
|
TNA
|
$618.41 million
|
10.97 million
|
0.95%
|
3X
|
Russell 2000 Index
|
|
SSO
|
$1.57 billion
|
7.07 million
|
0.92%
|
2x
|
S&P 500 Index
|
|
FAS
|
$1.13 billion
|
5.97 million
|
0.95%
|
3x
|
Russell 1000 Financial Services Index
|
|
QLD
|
$608.19 million
|
3.72 million
|
0.95%
|
2x
|
NASDAQ 100 Index
|
|
UPRO
|
$311.91 million
|
2.32 million
|
0.95%
|
3X
|
S&P 500 Index
|
|
ERX
|
$255.05 million
|
1.55 million
|
0.95%
|
3X
|
Energy Select Sector Index
|
|
UWM
|
$693.30 million
|
1.55 million
|
0.98%
|
2x
|
Russell 2000 Index
|
|
AGQ
|
$980.26 million
|
1.48 million
|
0.95%
|
2x
|
Silver Bullion
|
|
DDM
|
$215.82 million
|
518,000
|
0.95%
|
2x
|
Dow Jones Industrial Average Index
|
|
UST
|
$19.81 million
|
476,000
|
0.95%
|
2X
|
Barclays Capital U.S. 7-10 Year Treasury Index
|
For investors seeking for a leveraged play on the broad market
via large cap basket we have highlighted four products.
The ProShares Ultra S&P500 ETF (SSO), ProShares Ultra
QQQ ETF (QLD), ProShares UltraPro S&P500 ETF (UPRO) and
ProShares Ultra Dow30 ETF (DDM)
are some of the large cap leveraged ETF which are most
liquid.
As is evident from the table above,
SSO
and
UPRO
both track the S&P 500 Index. The former seeks investment
results that correspond to twice the
daily returns
of the index whereas the latter seeks to provide 3x the returns
of the S&P 500.
Despite having different investment objectives, both of these
ETFs charge the same expense ratio of 95 basis points. Both these
ETFs use swap contracts to achieve the leverage that they strive
for.
It is also very important to note that both of these ETFs are
rebalanced at the end of day, therefore generally on intraday
basis the ETF returns will not be equal to stated objective of 2x
or 3x the index returns (see more in the
Zacks ETF Center
).
Thankfully, the ETFs provide the cushion of high traded volume
and a substantial amount of popularity. SSO has an asset base of
$1.57 billion coupled with an average daily volume of 7.07
million shares. On the other hand, UPRO has attracted $311.91
million in its asset base with an average daily volume of 2.32
million shares.
The
ProShares Ultra Dow30 ETF (
DDM
)
is the appropriate choice for investors seeking for a leveraged
play on the Dow Jones Industrial Average Index. The Dow is by far
one of the oldest stock indexes in the world. Its components are
price weighted and it consists of only 30 large cap stocks (read
Inside the Dow Jones Industrial Average ETF
(DIA)
).
The ETF has been able to amass $214.96 million in its asset
base since its inception back in June of 2006. DDM is rebalanced
on a daily basis and provides exposure of 2x the daily returns of
the Dow Jones Industrial Average Index. It uses a variety of
Index swaps to achieve its stated leverage.
The ETF has an average daily volume of about 518,000 shares
and charges 95 basis points in fees and expenses.
Launched in June of 2006, the
ProShares Ultra QQQ ETF (
QLD
)
seeks to provide 2x the daily returns of the Nasdaq100 Index. The
NASDAQ 100 index includes the largest non financial companies
from the U.S. as well as abroad.
The ETF has a fairly large asset base of $608.19 million and
charges 0.95% as expense ratio. The ETF enters into swap
contracts with different financial institutions to provide the
leveraged exposure. QLD also has a very high average daily volume
of around 3.72 million shares (see
The Apple Effect and Nasdaq ETFs
).
Having discussed some of the large cap leveraged ETFs, let's
now focus on a couple of small cap ones.
The
Direxion Daily Small Cap Bull 3X Shares (
TNA
)
and
ProShares Ultra Russell2000 (
UWM
)
are two ETFs which provide leveraged play on the Russell 2000
index.
The Index measures the performance of the small cap segment of
the U.S. equity markets and is a subset of the Russell 3000
index. The benchmark is composed of 2000 stocks which make up
roughly 10% of the total market capitalization of the Russell
3000 index.
TNA provides 3x leveraged exposure whereas UWM provides twice
the daily returns of the Russell 2000 index. With an average
daily volume within striking distance of 11 million shares, TNA
is by far the most heavily traded leveraged ETF available in the
market. The ETF also exhibits popularity as indicated by its
asset base of $618.41 million (see
Three Small Cap ETFs with Impressive Yields
).
On the other hand, UWM also enjoys a high average daily volume
of more than a million shares and has been able to amass around
$694 million since its inception in January of 2007.
Also, both of these ETFs utilize index swaps to provide the
stated leverage. TNA charges an expense ratio of 95 basis points;
however, UWM is slightly more expensive than TNA charging
0.98%.
The financial sector has been one of the top performing
sectors this year. It has been pretty much leading the market
rally so far this year after a disastrous performance last fiscal
year.
The
Direxion Daily Financial Bull 3X Shares (
FAS
)
is an ETF that provides a leveraged play on the financial sector.
It seeks investment returns that correspond to 3x the daily
returns of the Russell 1000 Financial Services Index.
The index includes stocks of financial services companies from
the entire spectrum of market capitalization (read
Inside The Top Zacks Ranked Financial ETF
). With an asset base of $1.13 billion, FAS is one of the most
popular leveraged financial equity ETFs. It charges investors
0.95% as expenses, and on an average does about 5.97 million
shares daily.
The
Direxion Daily Energy Bull 3X Shares (
ERX
)
provides a leveraged exposure on the energy sector. It strives
for 3x the daily returns of the Energy Select Sector Index, which
measures the performance of companies from the oil and gas,
consumable fuels, oil and gas equipments and services etc.
ERX aims for the leverage by entering into index swap
contracts with different financial institutions. It charges an
expense ratio of 95 basis points and does about 1.55 million
shares daily in volume. It has an asset base of $255.05 million
(read
Uncertain about the Economy? Try Market Neutral
ETFs
).
The
ProShares Ultra Silver ETF (
AGQ
)
seeks 2x the daily returns of silver bullions which are U.S
Dollar denominated for London delivery. This means that along
with the volatility in the individual commodity price, the ETF
will also be subject to currency exchange rate between the U.S
Dollars and the Pound Sterling.
Obviously being a leveraged ETF the fund takes long
positions derivative instrument like silver futures and enters
into silver forward contracts with different financial
institutions to gain leverage on the underlying asset class (i.e.
silver bullion).
The ETF is also rebalanced daily and charges investors 95
basis points in fees and expenses. AGQ has a fairly large asset
base of $980.26 million and an average daily volume of about 1.48
million shares.
ProShares Ultra 7-10 Year Treasury (
UST
)
is a daily rebalanced leveraged long ETF which is designed to
generate 2x the daily returns of the Barclays Capital U.S. 7-10
Year Treasury Index. The index measures the performance of
intermediate term Treasury bonds which have a residual maturity
ranging from 7 to 10 years.
Most fixed income ETFs, especially long dated Treasury bonds,
have seen tremendous rally in the recent past mainly thanks to
the risk aversion of investors fuelled by the Eurozone debt
crisis and concerns over global economic slowdown. The Federal
Reserve's ultra low interest rate policy is also responsible for
attracting investor appetite towards these instruments.
However, from the third quarter onwards, investors have
started to show interest in the ETFs from riskier asset classes
and high yield bond ETFs for higher current income thereby
reducing the demand for the lower yielding Treasury bonds.
This has caused massive asset outflows from the Treasury Bond
ETFs and negatively impacted the intermediate and longer dated
Treasury Bond ETFs within this time frame (read
Long Term Treasury ETFs: Ultimate QE3 Play?
).
Nevertheless, this seems to be a short term phenomenon as it
is quite evident from the Fed's actions (such as Operation Twist)
that the low interest rate scenario, especially in the Treasury
bond front, is most likely to remain for quite some time.
Investors could go for a magnified exposure to the 7 - 10 year
Treasury bond segment should consider UST for short term trades.
The product has around $20 million in its asset base and on an
average does a good daily volume of around 476,000 shares. It
charges an expense ratio of 95 basis points.
Want the latest recommendations from Zacks Investment
Research? Today, you can download
7 Best Stocks for the Next 30 Days
.
Click to get this free report >>
PRO-ULT SILVER (AGQ): ETF Research Reports
PRO-ULTR DOW30 (DDM): ETF Research Reports
DIR-EGY BULL 3X (ERX): ETF Research Reports
DIR-FIN BULL 3X (FAS): ETF Research Reports
PRO-ULTR QQQ (QLD): ETF Research Reports
PRO-ULTR S&P500 (SSO): ETF Research
Reports
DIRX-SC BULL 3X (TNA): ETF Research Reports
PRO-ULT S&P500 (UPRO): ETF Research
Reports
PRO-ULT 7-10 YT (UST): ETF Research Reports
PRO-ULTR R2000 (UWM): ETF Research Reports
To read this article on Zacks.com click here.
Zacks Investment
Research
Want the latest recommendations from Zacks
Investment Research? Today, you can download 7 Best Stocks for
the Next 30 Days. Click to get this free report