Hate for Leveraged ETFs is Unwarranted

There is an awful lot of hate out there for leveraged ETFs. Microcap Speculator identified the Direxion 3X ETFs as "Wealth Destroyers." Jim Cramer called the Ultrashort Financials ProShares (SKF) the "ETF of mass banking destruction."

But the fact is that leveraged ETFs are nothing but a financial tool, which like any other, can be used either responsibly or recklessly.

The best known and most-criticized leveraged ETFs are Direxion's Russell 1000 Financials Bullish 3X ETF (FAS) and Russell 1000 Financials Bearish 3X ETF (FAZ), which aim to return triple the daily return of the Russell 1000 Financials Index in either a positive or negative direction.

Investors who play with these are 100% aware that they are playing with fire and have nothing to complain about when they lose money with them.

I also don't get the complaint that leveraged ETFs don't always accurately track the underlying over time. That's clearly spelled out in the prospectus which nobody bothers to read:

The return of each Fund for periods longer than a single day, especially in periods of market volatility, may be completely uncorrelated to the return of the Fund’s benchmark for such longer period.

The Funds are intended to be used as short-term trading vehicles for investors managing their portfolios on a daily basis. The Funds are not intended to be used by, and are not appropriate for, investors who intend to hold positions.

I feel no sympathy for anyone losing money in an ETF that they didn't bother to educate themselves about. If they just took three seconds to go to Direxion's home page, they'd see this:

Some have called for banning these ETFs, but why bother? They don't hide the fact that they're the financial equivalent of crystal meth, and traders who abuse them are destined to go broke sooner or later.

Why get in the way? If they don't use leveraged ETF's, they'll just try stuff like 100X leveraged f/x trading or huge options positions.

I’ll end with this quote from Chris Rock. Just substitute ‘ETFs’ for the drugs:

People love to get high. You could get rid of all the illegal drugs in the world and it won't mean sh*t. People want to get high. You could get rid of all the crack, all the herb, all the blow, you know what would happen? People will just think of new ways of getting high. That's right, guys would go into their basements and become scientists. 'Like dude, check this out, check this out, you know, if you get a baby's bottle, and you fill it up with a little gasoline and dead lima beans, and you suck it, you'll be f*cked up!'

Disclosure: Not crazy enough to play with these ETFs.

Comments

[Michael Comeau:]

Oh that's nothing. What about 100:1 leveraged f/x trading? Or the fact that we're allowed to trade financial stocks at all?


On Apr 22 04:48 AM Freya wrote:

> Why not eliminate option trading as well, options expire every three
> months which means you have to make a new trade every 3 months.
>
>
> at least, the ETFs don't expire.

Apr 22 08:39 AM

[raytayzmd:]

...I say ban ETF's altogether...the things have turned into a financial cancer...at the rate they're multiplying it won't be long before ETF's outnumber stocks!...and in reality, these things are NOTHING but PRODUCTS!...products for which financial institutions can charge management fees and brokers can sell and earn commisions...funds that could be used to finance new business and stimulate economic growth are siphoned off into the pockets of Goldman-Sachs and all the others...

Apr 22 09:57 AM

[Michael Comeau:]

Could you please be more specific in how these products siphon off funds that could be used to finance new business and stimulate economic growth?


On Apr 22 09:57 AM raytayzmd wrote:

> ...I say ban ETF's altogether...the things have turned into a financial
> cancer...at the rate they're multiplying it won't be long before
> ETF's outnumber stocks!...and in reality, these things are NOTHING
> but PRODUCTS!...products for which financial institutions can charge
> management fees and brokers can sell and earn commisions...funds
> that could be used to finance new business and stimulate economic
> growth are siphoned off into the pockets of Goldman-Sachs and all
> the others...

Apr 22 10:37 AM

[Michael Comeau:]

I agree - I think ETFs are a great way to target very specific parts of the market you're bullish or bearish on. They also have the added benefit of having lower fees and being more tax-efficient that comparable mutual funds.


On Apr 22 03:24 PM Freya wrote:

> The S&P 500 is divided into various types of investments. All
> the ETFs do is put the varying groups into baskets.
>
> The Nasdaq 100 is an early example of an ETF as is the S&P and
> DOW, Russell 1,000 and 2,000.
>
> Personally I like the idea of being able to target an individual
> sector within the SPX rather than having to buy the entire index.

Apr 22 05:31 PM

[Gary Gallo:]

Yahhh! Finally something with some leverage. That means you need to put 3X less money at it. Ya, That's right. Maybe put it all in Bonds and buy a few 3X under $10.00 with the interest.

Apr 22 08:45 PM

[cthayler:]

Right On! As an ETF only investor, these products are great if used wisely. I have seen so many articles in the last month bashing these. If you do not know this by now, you are asking to lose your money anyway (as Michael points out).

Also - these imbalances over time were evident mid 2008 with FXI/FXP.

Apr 22 08:55 PM

[blanco-dee:]

I hate banks,

and I hope Cramer's right that investment in SKF hurts

Apr 22 09:44 PM

[rcauvin:]

The real, emerging story is the increasing number of traders who are shorting both sides of the leveraged ETFs to profit from the long-term performance decay. In the long run, both the bullish and the bearish leveraged ETFs approach zero.

As more and more traders discover this strategy and short all the leveraged ETFs, what will happen?

Apr 23 12:34 AM

[donzelion:]

Concur with Rcauvin: traders have learned to short the shorts ETFs, and lever up the long leveraged ETFs: these products magnify volatility, but don't really change the fundamentals. I wouldn't expect a short or a long ETF to outperform its reference point - but simply to massively overshoot in both directions. That makes them good short-term trades, but lousy long-term holds.

Then again, I think about inverse leveraged ETFs the same way I think about temporary insurance on a rental car: I really hope I don't need it (that is, I hope I will lose 100% of the money I sink into it) - but if it becomes necessary, then at least I'll have some modest amount of coverage.

Apr 23 03:52 PM

[Shiva1968:]

Mutual funds that trade like stocks...some offering leverage to boot! Cool! For an individual investor that actively manages his/her account, this provides some real convenience to take advantage of the volatility of these markets. It also makes it very convenient to go short or long depending on ones outlook. I am pleased to have the option of using these tools when the right opportunity presents itself.

Apr 24 09:56 PM

[Freya:]

The S&P 500 is divided into various types of investments. All the ETFs do is put the varying groups into baskets.

The Nasdaq 100 is an early example of an ETF as is the S&P and DOW, Russell 1,000 and 2,000.

Personally I like the idea of being able to target an individual sector within the SPX rather than having to buy the entire index.

Apr 22 03:24 PM

[Freya:]

Why not eliminate option trading as well, options expire every three months which means you have to make a new trade every 3 months.

at least, the ETFs don't expire.

Apr 22 04:48 AM