Barron's(1/12) One-Day Wonders
Jan 10, 2009 00:06:01 (ET)
Suppose you had predicted -- correctly, as it turned out -- that the Chinese economy would slow following last summer's Beijing Olympics, causing China's stock markets to tumble. Also suppose that, to profit from your insight, you had invested in the ProShares UltraShort FTSE/Xinhua China 25, a leveraged exchange-traded fund (ticker: FXP) designed to go up by as much as twice the percentage that the FTSE/Xinhua China 25 Index falls on a given day.
When Chinese stocks crashed by 34% over the following four months, shouldn't you have reaped a gaudy return around 68%? Not exactly. In fact, you would have lost 56%. How can this be? FXP message boards recently were filled with stupefied investors using colorful language to express their bewilderment. They blamed everything from currency fluctuations to tracking error.
A ProShares customer-service representative had the real answer: The performance of some leveraged funds, including China UltraShort, is based on only the daily performance results of the underlying index, not long-term returns. The problem: diverging base-index values. Once an index rises or falls and a leveraged ETF moves in the opposite direction, they no longer share their original mathematical relationship. Relative performance doesn't hold after that first day.
Let's say Index A goes up 10% on day one, then drops 9% on day two, for a two-day return of about 0%. On day one, a leveraged short fund based on this index would go down 20%. On day two, it would jump 18% (two times the index's 9% drop). But because that rise would be from a base equalling only 80% of your original investment, you would now have less than 95% of whatever you had anted up. In other words, while Traditional Index A broke even, the UltraShort Index lost 5.6%.
As time goes on, the divergences can worsen, to the benefit or detriment of the investor. For this reason, the ProShares rep stated, such funds "probably aren't a good long-term investment." In fact, they are better suited for traders. That probably would be news to many of the people who have poured more than $20 billion into ProShares' exchange-traded funds, which come in forms ranging from Ultra Gold (UGL), which offers gold bugs the chance to earn twice the return provided by owning gold bars, to UltraShort ETFs created to earn double the profit from declines in the U.S. dollar, relative to the euro, yen and other currencies.
the problem is, every time you post the explanation, a couple days later the board is littered with more posts about FXP being manipulated, being a scam, and everyone should report them to the SEC, and they always invariably say, look at the FXP price 2 months ago! and look at it now!
and they just don't get it.
You're so right, it's a kind of (almost) thankless community service. Some people don't seem to have the initiative to do a few searches, spend some time researching and understanding what is actually going on. It's a frustrating way to be though, and I'd rather look under the hood and see what makes these things tick than hold on to my uninformed, unrealistic expectations while cursing the funds or the market or other people on the board - lol. Best of luck to you.
I know what you mean. I must admit that when I got into FXP and a few other leveraged ETFs [SRS, ULE] I took them pretty much at face value. As I went along and learned more I realized that they perform very differently than how they are supposed to or expected to perform. I'm in the process of shifting from buy and hold/accumulate mode to day trading mode with them. It's still tricky but I do know that it doesn't make sense to hang on to them for longer periods of time [months]. Good luck to you.
ProShares touts its 76 short and leveraged ETFs as "simple-to-execute sophisticated strategies, like shorting or magnifying your exposure to major indexes. No margin account. No margin calls." But market volatility has knocked some of these leveraged ETFs off track, exacerbating losses instead of giving a hedge against them.
Leveraged ETFs are offered by other firms, too, including Rydex and Direxion, and they display the same potential dangers.
Example 1: On Nov. 5, Direxion launched eight funds offering three times leverage. One of them, the Direxion Small Cap Bear Fund 3x (TZA), is designed to get three times the opposite return of the Russell 2000 index. Anyone who invested in it just before the Russell 2000 fell 3% from Nov. 5 to Dec. 31 might have expected to gain around 9%. The actual return? A loss of 31%.
Example 2: The Rydex 2x Russell 2000 (RRY) exchange-traded fund is built to generate twice the gain of the Russell 2000 index. Over the 10 trading days from Oct. 21 through Nov. 4, the Russell 2000 rose 2.9%. In that span, rather than advancing by twice that, or 5.8%, the RRY Ultra dropped 1.9%.
What's the lesson here? Investors seeking to profit from leverage might be better off doing it the old-fashioned way, by opening a margin account and buying or short-selling twice the amount of stock. There are dangers here, too, of course, and shorting stock is probably something only sophisticated investors should attempt.But at least investors would get the kind of performance they are paying for. With leveraged funds, in contrast, investors may get baffling long-term results that will leave them ultra-disappointed.
Tom Eidelman is a vice president of Eidelman Capital Management in St. Louis.
For Barron's subscription information call 1-888-BARRONS ext. 685 or inquire online at http://www.barronsmag.com/subscription/subscription.html.
(END) Dow Jones Newswires
January 10, 2009 00:04 ET (05:04 GMT)