Interest in Leveraged ETFs Waning?

By Murray Coleman

A super-juiced Direxion fund (FAS) has been leading a rush for the exits by investors from leveraged ETFs. Is it the market, or is it increased regulatory scrutiny?

Inverse and leveraged ETFs took it on the chin last month.

Just look at money flows for domestic-focused equity categories. Leveraged U.S. stock ETFs had nearly $2.4 billion in net outflows in July. At the same time, U.S. long-only equity funds not employing leverage recorded net inflows of $7.8 billion, according to the most recent National Stock Exchange data.

International leveraged equity ETFs had net outflows of $38 million. The same type of funds that didn’t use leverage—just went long—as a group had inflows of more than $3 billion.

More niche corners of the market also couldn't escape fleeing investors. Commodity ETFs using leverage had net outflows of $53 million; traditional long commodity funds had net inflows of $65 million.

The list goes on, but among individual ETFs of all classifications, the Direxion Daily Financials Bull 3x (FAS) was the biggest loser in terms of outflows with some $984 million in July. (Don’t feel too sorry for its sponsor—the ETF still has more than $1 billion in assets.)

As we head into the last half of August, it’ll be interesting to see how sentiment treats this category. Paul Amery, editor of our European Web site, notes in Tuesday’s feature that European investors are already talking about alternative ways to gain leverage.

Also, Deutsche Bank has decided to halt issuing new shares of the PowerShares DB Crude Oil Double Long Exchange-Traded Note (DXO). Although the company wasn't talking, numerous reports pointed to ongoing concerns that the SEC and FINRA were raising the spotlight too brightly to suit Deutsche Bank's comfort level. (See related story here.)

As if that wasn't enough, also on Tuesday the SEC and FINRA issued a joint statement officially warning investors against the dangers of leveraged ETFs. (See more here.)

Public flogging of sophisticated investment vehicles by regulatory bodies are sure to be an ongoing saga. Still, it might be worth keeping an eye on some of last month’s other big losers (by net outflows in July):

• ProShares Ultra DJ Financials (UYG) $336 million

• ProShares Ultra S&P 500 (SSO) $377 million

• Direxion SmallCap Bull 3x (TNA) $64 million

• ProShares Ultra QQQ (QLD) $87 million

• ProShares Ultra DJ Basic Materials (UYM) $101 million

• Direxion LargeCap Bull 3x (BGU) $99 million

• Direxion Energy Bull 3x (ERX) $78 million

It seems like a good bet that most of the reasons for traders fleeing these funds had to do with market forces rather than regulatory fodder. Still, some interesting blips showed up in the monthly flows data. It will take more time to monitor the situation to see any patterns developing. But one thing seems to be clear—ETF investors are no better in making short-term moves than mutual fund investors. Consider that:

• While the 200% leveraged UYG had net outflow during the month, the nonleveraged SPDR Financial ETF (XLF) had net inflow ($269 million). And even though both funds go in the same general direction—long only—XLF had net outflows through the opening seven months of the year totaling $1.3 billion. By contrast, the 200% leveraged UYG had net inflows of $678 million year-to-date.

• The SPDR S&P 500 (SPY) had net inflows of slightly more than $3 billion in July. Meanwhile, the 200% leveraged SSO went the other direction with net outflows. Over the course of a full year, SSO had more than $1.4 billion in net outflows; SPY also had relatively heavy outflow topping $27.4 billion—more than double outflow totals at the same time last year for the industry’s biggest fund.

Original post

Comments

[markfl:]

I read the "warning" mentioned in this article www.indexuniverse.com/..., which moved as part of a story on Reuters last night. Honestly, I think you'd have to be about dumb as a stump to not to comprehend the risks this warning attempts to offer protection from. This government "nanny state" stuff is getting a little extreme here.

Aug 19 04:47 AM

[chap08:]

Disagree. I've seen these things pitched hard in retail ads with no explanation and nothing other than standard warnings. Reality is that the public as a whole are financially illiterate and need protecting from themselves. We learn that over and over.


On Aug 19 04:47 AM markfl wrote:

> I read the "warning" mentioned in this article www.indexuniverse.com/...,
> which moved as part of a story on Reuters last night. Honestly, I
> think you'd have to be about dumb as a stump to not to comprehend
> the risks this warning attempts to offer protection from. This government
> "nanny state" stuff is getting a little extreme here.

Aug 19 07:23 AM

[Alan Young:]

When markets are volatile, leveraged ETFs will not track their indices over time, so sensible traders move to non-leveraged alternatives.

That's sensible traders, mind you. The clueless shouldn't use these products. Can brokers be referees as to who is qualified?

Aug 19 08:34 AM

[Suzanne H.:]

But where do you draw the line on protection? How about those that had shares of GM, Citi, and many others, or those that dabble in options.

Educating the public and especially financial professionals on the issues is the key. I like Finra's statement: “Leveraged and inverse ETFs can be appropriate if recommended as part of a sophisticated trading strategy that will be closely monitored by a financial professional.”

I have provided a simple method for trading leveraged ETFs to get one started in building their strategy: seekingalpha.com/insta... and legacyfunds.wordpress.com/ Similar to what I covered on my panel at the January Inside ETF conference.

On Aug 19 07:23 AM chap08 wrote:

> Disagree. I've seen these things pitched hard in retail ads with
> no explanation and nothing other than standard warnings. Reality
> is that the public as a whole are financially illiterate and need
> protecting from themselves. We learn that over and over.

Aug 19 09:38 AM

[BlockTrader:]

Finally we're getting more people agreeing that these additional warnings and disclosures for Leveraged ETFs were appropriate and perhaps needed but MORE importantly, fewer people calling for them to be outright banned. As many of us on this blog have said before, just don't trade them if you don't understand them. Don't call for an outright ban. These ETFs are providing increased liquidity to the market and daytraders an increased opportunity to recognize, react and capitalize on short term movements.

The reality is that unleveraged ETFs often move LESS than individual stocks but without a lot of the risk of individual stocks. The daily moves in LEVERAGED ETFs are often comparable to high beta individual stocks. I simply can't imagine why anyone would want LESS choice in the market place...... There are plenty of things out there like currency and fixed income that I don't mess around with ebcause I don't understand them.... Don't trade Leveraged ETFs if YOU don't understand them.....

Aug 19 08:04 PM

[Niner:]

My online brokerage adds an additional 65% to the current 35% margin maintenance requirements for the 3x ETFs and an additional 40% to 2x ETFs. Technically you can do your own leveraging by using your margin account to buy 3 times the amount of XLF as FAS. One thing I like about the 3x and 2x ETFs is; I don't like to hold them overnight and definitely not over the weekend. I'm afraid if I leverage a regular ETF I won't be as cautious. As far as I'm concerned the 3x and 2x ETFs are great daytrading vehicles. But, I can live without them.

Aug 19 08:09 PM

[Nick Ive:]

What would you have if you held a 2x leveraged ETF for 135 years? Most people would have you believe that your fund will bleed away to nothing.

But this is not true. Here is an article that shows what really happens: www.ddnum.com/articles.... The answer is that you get rich.

Aug 19 09:58 PM

[Paulo:]

Checked your link Nick Ive -- it said this:

"Leveraged ETFs can drop to zero if the market drops enough in one day. You can lose all your money."

Aug 19 10:37 PM

[TCK:]

Another sign of the long term effects. Recently, both FAS and FAZ had reverse splits.

Think about it ?

Aug 20 06:39 AM

[predictorma...:]

Leveraged ETFs make no sense unless you have a clue where the underlying sector or market is going. Oh and by the way, these days everything seems to be going in lockstep and so even thinkinig a sector will go opposite the overall market is risky.

I HAVE NO IDEA WHERE ANYTHING IS HEADED.

And I don't think anyone else does either. You could read SA all day and not have a clearer idea. I have no conviction that would bring me to buy 2X or 3X in either direction.

Aug 20 09:34 AM

[BlockTrader:]

Niner, good point with the margin on the XLF and yes, discount brokers have increased maintenance and margin requirements for these. However don't you find it easier to technically spot and "get in" on a move that is 6% wide vs one that is 2% wide? I guess they occur over the same time frame so perhaps the answer there is no but I feel that you have "more of a trade" to work with when the actual price moves more... vs just added $$$ to you unleveraged XLF position.


On Aug 19 08:09 PM Niner wrote:

> My online brokerage adds an additional 65% to the current 35% margin
> maintenance requirements for the 3x ETFs and an additional 40% to
> 2x ETFs. Technically you can do your own leveraging by using your
> margin account to buy 3 times the amount of XLF as FAS. One thing
> I like about the 3x and 2x ETFs is; I don't like to hold them overnight
> and definitely not over the weekend. I'm afraid if I leverage a regular
> ETF I won't be as cautious. As far as I'm concerned the 3x and 2x
> ETFs are great daytrading vehicles. But, I can live without them.

Aug 20 12:35 PM

[Suzanne H.:]

True the leverage isn't what's important here as much as having an inverse. For accounts that can't short, especially retirement accounts, that is the only way to potentially profit on the downside. I wouldn't be able to do anything else for my clients' IRAs. I end up using the double inverse not to get net margin exposure (I take half the position sizing), but because the bid/ask spreads and volume are better than the single inverse.

Trading these via a short term technical system works best, and is hard enough in this market -- can't imagine going by a discretionary system because as "predictorma" stated above, it is hard to know where things are headed -- my hunch says down but technically all triggers for the short side have been very brief (barely lasting a day).

On Aug 19 08:09 PM Niner wrote:

> > 3x and 2x ETFs are great daytrading vehicles. But, I can live without
> them.

Aug 20 01:20 PM

[Dr. O:]

Like Suzzane has mentioned, leveraged ETFs work great in trending markets, if you want to hold them a while. The mathematics eat your money over time in non-trending markets.

Aug 20 05:06 PM