New leveraged ETF’s to suffer from less erosion?

By: ispeculatornew
Date posted: 01.28.2010 (5:00 am) | Write a Comment  (8 Comments)

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Leveraged ETF’s have many pros and cons but the main problem around them, especially when they were first introductedto the market was the misunderstanding of how they worked by the investors and traders. Since then, we have learned a lot about how they work, their good and bad sides. One of the most important characteristics of course is that these are generally created for short term trading rather than long term investing.

The main reason behind it is that volatility can have an important impact on the return of the ETF and as time goes by, the return will not be correlated as much with the underlying index it is intended to track. A product that had been discussed for some time is about to be introduced as Direxion will be launching leveraged ETF’s with a monthly rebalancing (instead of the traditional daily rebalancing that is currently offered).

You can see the names of the different ETF’s that are being launched in the SEC filing made by Direxion here.

This will diminish significantly the impact of the daily rebalancings which is most often named when investors or the media criticize leveraged ETF’s.

But there are other consequences:

#1-An ETF that returns 3x the leverage of an index could lose almost all of its value in one month.

Example: Imagine you invested in an ETF that returns 3x Crude Oil returns. If Crude oil were to return -30% (which is a big movement but something that has been seen in the near past), your ETF would return a crazy -90%! Of course, it could also be the opposite.

#2-Also, like the daily leveraged ETF’s, it is important to consider the product specifications when entering a trade. When you have a position at the start of the month, you can expect to track the index correctly. But the later you enter in the month, the less true that is.

I think these ETF’s will certainly attract their shares of investors. Are they better than daily leveraged ETF’s? No. They are simply different and should attract a different type of investor. Paul Justice, ETF strategist at Morningstar, said the funds were a better option for longer term investors. “It allows investors to invest in a sector over a 30-day time frame and get a more accurate return if they buy at the beginning of the month. If you’re a long-term investor, you still shouldn’t expect to earn the two or three times leverage,” he said. It will be very interesting to see

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8 Comments

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