Leveraged and inverse exchange traded funds have faced regulatory scrutiny and negative headlines in recent years, but short-term traders continue to use the high-octane ETFs to trade entire markets and sectors.
The ETFs, which magnify daily performance and can move in the opposite direction of the market, are generally not suitable long-term investments.
However, regarding claims that leveraged and inverse funds contribute to market swings, “we can point to several factors that suggest leveraged and inverse ETFs are not to blame and can offer a few plausible explanations for the increase in volatility based on economic fundamentals,” Michael Rawson wrote in a Morningstar article. [Leveraged and Inverse ETFs: What You Should Know]
Last year’s market was characterized by a high VIX and volatility, and there about 249 leveraged and inverse ETFs trading, reports Rawson. However, this area of the ETF business has about $32 billion in assets under management, which is a mere trickle compared to the $1 trillion industry.
A few other facts about leveraged and inverse ETFs:
- If leveraged and inverse ETFs were amplifying market volatility, we would expect that assets would ebb and flow, causing peaks in volatility and but then crashing back to a trough, according to the report. However, assets in leveraged and inverse funds have been flat as a board, consistently hovering between $30 billion and $36 billion since March 2009. [Credit Suisse Launches Neutral Global Long-Short ETN]
- Leveraged funds need to re-balance daily, and should be monitored daily as well. These are not buy-and-hold investments and can actually harm a buy-and-hold investors portfolio if held for the long term.
- Inverse ETFs bet against the direction of financial markets, so they make money when market or sectors are declining. Inverse funds also lose money when markets are rising, hence the need for monitoring. [These ETFs Short Large-Cap U.S. Large Caps]
- Leveraged ETFs follow daily market changes in the stock market and can double or triple a bet depending on the fund. If a leveraged fund is betting on the upside, and the market moves up, the potential for higher returns is up two or three fold. But the same holds true for losses and market downswings. This is why investor must be prepared for risk and must watch these funds daily.
Tisha Guerrero contributed to this article.