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On Thursday (11/12), we hosted here a live discussion on the topic of leveraged ETFs.

The panelists are three SA contributor portfolio managers who use ETFs in client portfolios and write actively on new developments in the field of exchange traded funds. Here are the panelists, their credentials and a preliminary writeup from each of them with their views on leveraged ETFs:

Don Dion is the publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors Don’s commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds.

Don is also president and founder of Dion Money Management, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Here's Don's personal overview of leveraged ETFs.

David Fry has devoted over 35 years to the business of trading and portfolio management. He is registered as an arbitrator with both the National Association of Securities Dealers (NASD) / FINRA and the National Futures Association (NFA). Dave founded the ETF Digest in 2001 and was among the very first to see the need for a publication that provided individual investors with information and advice on ETF investing. Here's Dave's personal overview of leveraged ETFs.

Roger Nusbaum is an Arizona-based financial advisor with Your Source Financial who builds and manages client portfolios using a mix of individual stocks and ETFs. Here's Roger's personal overview of leveraged ETFs.

This is the first of a series of live discussions from this panel on the topic of ETFs. We plan to convene monthly on different topics of interest in ETF portfolio building, while soliciting real-time comments and questions from our community. Set up an email reminder below to make sure you don't miss it.

Mick Weinstein:
Hi everyone - we'll begin in a few minutes, at the top of the hour.

Roger Nusbaum:
ready when u are

Mick Weinstein:
OK, let's begin... looks like Roger and Don are online, and hopefully Dave will be soon

Mick Weinstein:
Here's how we'll run this... I'll begin with some directed questions to the panelists

Don Dion:
Good Afternoon.

Mick Weinstein:
hi Don

Mick Weinstein:
meanwhile, the community can ask questions/leave comments in the little box below

Mick Weinstein:
and in the second half of the session, I'll begin splicing in those

David Fry:
Hi everyone!

Mick Weinstein:
I think the issues/concerns around the leveraged ETFs have been hashed out pretty well over the past year or so, so I'm not interested in rehashing them

Mick Weinstein:
hey Dave

Mick Weinstein:
what I would like to do is to address two things

Mick Weinstein:
1) How you use these products (if you do) and what other ways you've seen that they've been used responsibly and perhaps effectively: what products, what triggers, what *time frame*

Mick Weinstein:
let's start with you, Roger

Mick Weinstein:
you said in your introductory writeup that you used the double short S&P at certain times

Roger Nusbaum:
I use SDS as a hedge when I receive the need for defensive portfolio action

Roger Nusbaum:
the positions tend to start out small...

Mick Weinstein:
what was your trigger for that?

Roger Nusbaum:
Maybe 2-3% of the portfolio and let it grow to more if the market goes down before taking some off, as for triggers...

Roger Nusbaum:
i rely mostly on the SPX going below its 200 DMA to initiiate defensive action...

Roger Nusbaum:
defensive action can included SDS or selling down some positions or both.

Mick Weinstein:
why would you chose SDS over selling down positions?

Roger Nusbaum:
i tend to prefer to hold individual issues for a long period of time. sometimes this is doable and sometimes not...

Roger Nusbaum:
if a stock or ETF is still the single best proxy for something (that is obviously subjective) then I may not want to sell it just to sell something

Mick Weinstein:
Dave has a whole portfolio devoted to leveraged ETFs, so we'll definitely get to that

Mick Weinstein:
but Don, you said you don't use leveraged ETFs in your portfolios

Mick Weinstein:
is that a matter of principle/mandate... or could you imagine a scenario where you would use one?

Don Dion:
Sometimes I do, for targeted positions. I have owned UDN for a while now.

Mick Weinstein:
Oh, ok... why did you chose UDN over other options?

Don Dion:
Because its a diversified bet against the US dollar, which I thought was weakening.

Mick Weinstein:
but UDN isn't leveraged, right... just short USD?

Don Dion:
Yes, it is just one-time exposure, but it uses futures.

Don Dion:
It is an inverse, correct.

Mick Weinstein:
could you imagine a scenario where you'd use a leveraged ETF within your framework?

Don Dion:
Our trading time frame is too long to use a leveraged ETF product. I can't predict the future, but the type of investing we do isn't conducive to leveraged ETFs.

Mick Weinstein:
I see... so Dave, let's talk a bit about your use of leveraged ETFs

Mick Weinstein:
in your writeup http://seekingalpha.com/article/172749-dave-fry-thoughts-on-leveraged-etfs

Mick Weinstein:
you mention an "all leveraged ETF program" at your ETF Digest

Mick Weinstein:
how is that structured?

David Fry:
Yes

David Fry:
We have four all ETF portfolios. Three utilize when indicated "unleveraged" issues but one new program, Dave's Special Portfolio utilizes only leveraged ETFs. It's only be going for three weeks now.

Mick Weinstein:
how often do you trade into/out of leveraged ETFs?

David Fry:
We're using only 12 at a time

David Fry:
we're in them for a day to a couple of weeks max.

Mick Weinstein:
the most liquid ones?

Mick Weinstein:
interesting... so who is your investor - what profile?

Roger Nusbaum:
Dave, if you use narrower levered products how do you assess or try to manage the effect of daily compounding "not working?"

David Fry:
We have all of them on the menu but have what we call the "Dirty Dozen" as a first team. Then have others in reserve we can bring in when liquidity and interest build.

David Fry:
I haven't experienced that over the time frames we've used.

Roger Nusbaum:
meaning short term trades?

David Fry:
We're making money using them. They're not perfect sometimes but that's okay.

David Fry:
We're using them only for short-term trades.

Mick Weinstein:
your indicators are entirely technical - or are you using fundamental considerations as well?

Roger Nusbaum:
k, TY

David Fry:
If they're supposed to make 2 or 3% but only capture 1.5-2% I can live with that sometimes.

David Fry:
Naturally, these are intended for aggressive traders.

David Fry:
We use the unleveraged issues for all the other portfolios.

David Fry:
And, of course, those have minimal tracking inefficiencies.

Roger Nusbaum:
if may add one more thing on use of SDS v selling positions it reduces turnover and can minimize the consequence of getting whipsawed in the context of a longer term portfolio.

David Fry:
Everything we do is technically based.

David Fry:
Systematic and technical.

David Fry:
Good point Roger.

Mick Weinstein:
let's talk a bit about an issue that has become somewhat controversial - the regulation of these instruments

Roger Nusbaum:
sorry to cut you off there thot we had a little pause

Don Dion:
very interesting topic.

Mick Weinstein:
FINRA has been getting active on a couple fronts here

Mick Weinstein:
Don wrote recently that the increased margin requirements that will go into effect in a couple of weeks are good - that "Non-traditional ETF funds should require a separate set of regulations than their traditional peers. A continued coordinated effort from regulatory agencies will be an important step in protecting investors."

David Fry:
We tend to concentrate on the most liquid issues first but keep in mind that others on the bench may be new and volume is not yet building. Further it may be that some will become hot later and then we'll use them.

Mick Weinstein:
in general, I think it's safe to say that Don has been supportive of the regulatory efforts in this area - true Don?

David Fry:
I don't agree with that Don.

Mick Weinstein:
whereas Dave has been highly critical

Mick Weinstein:
there you go!

Roger Nusbaum:
FWIW....

Don Dion:
Derivatives are a whole different barrel of fish. Doesn't matter if we are talking about futures-based commodity funds or leveraged funds.

Roger Nusbaum:
options that are in the money on thursday expire worthless all the time wiping people out...

Roger Nusbaum:
this does not happen with ETFs...

David Fry:
right

Roger Nusbaum:
if someone thinks people should fill out something like...

Roger Nusbaum:
options paperwork to trade levered funds...

David Fry:
how about mutual funds that are down 40-80% being better regulated?

Don Dion:
There is a fundamental difference between something that tracks equities and something that tracks derivatives

Don Dion:
mutual funds are more regulated...more so by the day.

Roger Nusbaum:
then so be it but these are not as evil as all that.

David Fry:
they track an index Don

Don Dion:
Its the "how" that is different.

David Fry:
"how now" Don?

Roger Nusbaum:
i would further add that it took the greatest dislocation of all time to create this issue in the first place....

David Fry:
right Roger.

Roger Nusbaum:
were it not for the ceasing up of markets they probably would not be so reviled.

Roger Nusbaum:
but "options paperwork" w/b fine I gthink

David Fry:
low hanging fruit for people to single out

Don Dion:
In order to replicate what you can do with a leveraged ETF...I agree with Roger

Don Dion:
That's what I was about to say. Margin.

Roger Nusbaum:
in that light it becomes about firms covering themselves which they need to do.

David Fry:
Look, I was an options prinicipal, CTA and so forth. Having firms disallow brokers and F/A's from allowing clients to protect themselves with even "unleveaged" issues is absurd.

Roger Nusbaum:
brokerage firms that is.

Don Dion:
Exactly.

Roger Nusbaum:
yes banning them is redic.

Mick Weinstein:
Dave: 'Edward Jones is prohibiting its clients and advisors from trading in leveraged ETF products. It sounds paternalistic on the surface but masks the real agenda—they don’t want clients deviating from their high-fee plans sold to the masses door-to-door.'
http://seekingalpha.com/article/145855-absurd-inverse-and-leveraged-etf-product-whining-updated

Mick Weinstein:
Roger and Don, thoughts on that?

David Fry:
Right

Roger Nusbaum:
Nothing says "your broker is a moron" like he can't use certain products

David Fry:
The real agenda is to prevent clients from leaving "the plan"

David Fry:
Further, it's an insult to brokers intelligence and trust in them.

David Fry:
Edward Jones just hustles high fee mutual funds "door to door". They wouldn't want brokers to use their brains.

Don Dion:
Regulatory efforts have been aggressive the past 6 months. I think that EJ is just trying to cover itself (from upcoming regulation). I think it was genuinely worried that regulators were going to accuse them of using them in a bad way...look at all this regulation with futures-based commodity funds...how disruptive it has been to trading. You can't really blame someone from trying to protect their firm...I agree that it probably didn't have much to do with the clients...

Don Dion:
I think it was an impulsive move in the wake of the FINRA announcement

[Comment From Jonathan LissJonathan Liss: ]
Why the need for sudden regulation when levered funds in the form of mutual funds have been around for over a decade and the SEC reviewed leveraged ETFs for 3 years before allowing to come to market?

David Fry:
Smoke screen more likely

David Fry:
right Jonathan.

Roger Nusbaum:
exactly the point. these are not a dangerous as all the fuss would imply, especially compared to how people misuse options or load up on lottery ticket biotechs.

David Fry:
right Roger.

Don Dion:
Yeah, there's an example where ETFs make something safer...biotechs, junior miners...etc...

Mick Weinstein:
Don, you wrote that you used single short ETFs at selective points during the crisis

David Fry:
singling them out was just an effort by regulators to pick on an easy target that Cramer and others had been screaming were "evil".

Mick Weinstein:
what were your triggers for that?

Mick Weinstein:
(I realize this is inverse, not leveraged ETFs...)

David Fry:
Further, with markets going up, no ones complaining about the long leveraged issues.

Don Dion:
We use a momentum based system, we used them in September 2008 into October

David Fry:
Used what Don?

Mick Weinstein:
so a proprietary system?

Don Dion:
Yes. We use it in our newsletters and some client portfolios.

[Comment From Phil BakPhil Bak: ]
What role, if any, do you project leverage ETFs to play outside of the tactical and day trading worlds - particularly in strategic allocation portfolios?

David Fry:
Phil, they can be used for either swing traders or day traders.

Roger Nusbaum:
Phil, I use them in small doses as a hedge for an extened period of time if that addresses your question.

Mick Weinstein:
Roger, how long would you use a double short ETF, given the daily rebalance concern?

Roger Nusbaum:
the broadest based funds...

Roger Nusbaum:
don't have anywhere near the compounding "not working"....

Roger Nusbaum:
that the sector funds do so for as long as needed really. check the charts for the broad based and you'll see not perfect...

Roger Nusbaum:
but not disasterous

David Fry:
Bill D........you make a good point regarding leveraged ETFs vs futures.

Roger Nusbaum:
lemme stress moderation here thogh.

Don Dion:
Leveraged ETFs contain futures.

David Fry:
Roger, we've had the same experience.

Roger Nusbaum:
yeah that was behind my question earloer to you Dave

Roger Nusbaum:
about the narrower or sector funds

David Fry:
Ok Don, so do many mutual funds according to their prospectus using futures.

Roger Nusbaum:
If SPX drops 90 points today I know SDS will be up a ton.

Don Dion:
I guess it depends on how you are trying to make money. Looking for a 100% hedge, looking to lock in a profit...etc..

David Fry:
Don, it's not like you need a geiger counter with leveraged products.

[Comment From Gregg KillorenGregg Killoren: ]
When using a leveraged product in a client's portfolio like SDS do you believe that, say for example having 2 percent of the portfolio in SDS is really like a 4 percent position, because of the double leveraging or is the math more fuzzy than that?

Roger Nusbaum:
I'm trying to go down less than the market if it is going to go down a lot.

Roger Nusbaum:
Greg K--YES exactly

David Fry:
Gregg.........it depends how long you hold it.

David Fry:
Gregg, compounding is a factor over long periods with leveraged products which is why our approach is tactical, technical and shorter-term in nature. They are well-suited to traders.

Don Dion:
There are also other factors that impact the trading of a leveraged ETF (or any ETF for that matter) beyond "what they track". Since they trade throughout the day, there are considerations that you wouldn't have to worry about with a mutual fund.

Roger Nusbaum:
Don, yes there are distortions around the open and the close

David Fry:
The unleveaged issues are terrific additions for individuals wishing to hedge their risk over long periods. Clearly superior to options or futures for example.

Don Dion:
Or in anything that is illiquid...

Mick Weinstein:
are these distortions worse with these ETFs, Don?

David Fry:
For mutual funds, just "timing scandals" then.

Don Dion:
I'm referring to premiums/discounts. Dislocations in daily pricing.


David Fry:
We time our entries into leveraged issues to avoid pricing inefficiencies.

Roger Nusbaum:
important for people to realize the first 20 minutes of the day is a bad time to trade

David Fry:
Correct Roger

Roger Nusbaum:
the levered ETFs that is

David Fry:
Let things settle in.

Mick Weinstein:
very interesting point - and also near the close?

David Fry:
That can be true as well.

Don Dion:
Market makers in these products widen out their quotes at the beginning and end of the day. This has to do with their own hedging needs. It also has to do with products opening up in the morning, etc.

Roger Nusbaum:
potentially yes btu I have been told the open is worse

[Comment From Gregg KillorenGregg Killoren: ]
Thanks. Let's say I put clients in SDS today to hedge against losses (and possibly for tax purposes) intending to hold a small position until the end of the year. Is a month and a half too long?

David Fry:
Sometimes you get those "stick saves" at the close with buy programs.

Don Dion:
The opening is worse, I agree. Also, products that track foreign ordinaries will trade at different spreads when the underlying markets are closed, etc.

Roger Nusbaum:
Greg--maybe...

Roger Nusbaum:
the combo of up and down days could be just fine..

Roger Nusbaum:
or not no way to know, but with a small position i have no qualms...

Roger Nusbaum:
holding that long

David Fry:
Gregg...Not necessarily, we've done okay with some longer term holds of 4-6 weeks. But you might be better with SH for example.

Mick Weinstein:
it's interesting to me that Roger seems to use leveraged ETFs to 'smooth out the ride', Dave uses them as central positions (in one portfolio), and Don doesn't actively use them - but uses inverse ETFs

Roger Nusbaum:
hence the flexibility

David Fry:
Yes, Don used UDN.

Don Dion:
A lot of it has to do with how active of a trader you are, how high your risk tolerance is.

Mick Weinstein:
Don wrote: "If you look at the notational trading volume numbers and net assets each month, it is apparent that traders are turning over triple-leveraged funds fast... It is fairly obvious that they are used, most of the time, by professional traders." http://seekingalpha.com/article/172750-don-dion-thoughts-on-leveraged-etfs

David Fry:
That's why we have four distinct portfolios that range from conservative to aggressive.

Mick Weinstein:
thoughts on that, Dave and Roger?

Roger Nusbaum:
people have always chased heat and that will always be the case...leverage junkies.

David Fry:
Yes, you need to be a sophisticated and aggressive investor to trade them as we do in the one portfolio. Heavy turnover and high risks.

Mick Weinstein:
could it be automated trading?

Don Dion:
It definately is.

David Fry:
dark pools?

Don Dion:
a lot of it. computers.

David Fry:
sure

Roger Nusbaum:
you'd have to think some but not positive

Don Dion:
algorithms, etc.

David Fry:
but that's what provides the good liquidity in some but not others

David Fry:
first rule to follow in that regard is to stick with liqudity as a priority.

Mick Weinstein:
OK, our time is up... thanks to our panel - the plan is to do a session every month or so on another topic in portfolio building with ETFs

David Fry:
you can get really hurt in illiquid issues for retail investors.

Don Dion:
I agree, liquidity should be a priority, especially when dealing with more complex funds. If it is something you have to get in and out of quickly, def. pick liquid funds

Don Dion:
thanks!

David Fry:
thanks

Roger Nusbaum:
thanks guys

Mick Weinstein:
thanks for all the questions that came in

Mick Weinstein:
sorry I couldn't post them all

Mick Weinstein:
please leave comments below this post on what topics you'd like us to discuss in upcoming discussions

Mick Weinstein:
to read more from our panelists on their thoughts on leveraged ETFs see:

Mick Weinstein:
Don http://seekingalpha.com/article/172750-don-dion-thoughts-on-leveraged-etfs

Mick Weinstein:
Roger http://seekingalpha.com/article/172740-roger-nusbaum-thoughts-on-leveraged-etfs

Mick Weinstein:
and Dave http://seekingalpha.com/article/172749-dave-fry-thoughts-on-leveraged-etfs

Mick Weinstein:
thanks everyone!

Source: Leveraged ETFs: A Seeking Alpha Expert Panel