Dave Fry: Thoughts on Leveraged ETFs

As a starter for our upcoming live discussion on leveraged ETFs (Thursday at 2pm ET), we asked Dave a few questions regarding these products:

1) How, if at all, do you use leveraged ETFs in your own portfolios?

At the ETF Digest, we’ve recently launched an all leveraged ETF program for Dave’s Special Portfolio. In it we’ve broken down the current group to a dozen that are currently popular based on performance and liquidity. At the same time, we keep another two dozen or so in reserve to bring out as interest and liquidity build. Our approach is very short-term, with holding periods of a day or so if unsuccessful, to no more than two weeks if successful.

We try to incorporate as many uncorrelated issues as possible; however, in the current market environment, few in that category are available as many sectors are trending in the same direction.

It’s too soon to say how successful this will be, but it’s only for the most aggressive traders.

2) Do you see any significant tactical differences in the approaches of the leveraged ETF providers (ProShares, Direxion, Rydex) in terms of composition or methods of capturing the desired return? Do you prefer certain approaches over others?

In addition to ProShares and Direxion, we use DB commodity leveraged ETNs in the same manner. The more liquid issues are always the best to use.

3) Leveraged ETFs have been scrutinized all over for only being appropriate for short-term traders, due to the daily reset and problem of longer-term compounding. This summer, FINRA issued a direct warning to RIAs about the use of these ETFs in longer-term client portfolios. Do you think the leveraged ETF providers have done an adequate job in explaining these products? And do you think they are commonly misused by RIAs? Misused by retail investors?

Everything gets misused in our business, whether mutual funds, stocks, commodities, options and so forth. I don’t think issuers need to play nanny to investors, but should lay out the risks. Clearly, leveraged issues have been the low hanging fruit for regulators and the media to single-out as “evil” during the bear market. However, since markets have been rising, critics have been completely mute as the “bullish bias” remains a fixture for the financial media. They’re okay when markets rise - but not when markets are going south.

The FINRA warnings are a smoke screen, and I say this as a former FINRA Arbitrator. Even sillier have been restrictions by many wire-house firms on using “unleveraged” issues. ETFs like SH are the most innocuous and yet effective way for the average investor and financial advisor to hedge their market exposure. The main reason, other than the false “we’re looking out for you” reasons, is to prevent advisors and investors from breaking from their carefully fee-laden financial plan and actually “trading”. You are not permitted to sell with these plans. It’s like a penalty for an early withdrawal from a 12-b1 fund.

Add to this recent interference from the CFTC regarding commodity position limits on some ETFs and they have matched FINRA in their regulatory sector. Products like oil ETFs had a regulatory exemption letter for position limits. Investors proceeded with confidence in the durability of such a letter. But, again, politics of “we’re doing something” enters in and it’s easy pickings of more low hanging fruit for regulators.

What do the operators of these funds then do for investors? They turn to the more expensive OTC market to accomplish what is denied by CFTC. Who benefits? OTC trading desks at a few large firms like Commissar Gensler’s former firm, GS. So, the motto of regulators here has been “break it first and fix it later”. It’s a great disservice to innocent investors.

4) What are your thoughts on MacroShares' leveraged Housing exchange traded products (DMM, UMM)? Are these likely to face the same issues as the MacroShares oil products? If someone has a large percentage of net worth in home equity, would DMM make sense as a hedge against home prices falling?

I don’t use them.

Comments

[fjpenney:]

With leveraged ETF's, from my experience the timing is of paramount importance. I base much of my US investments on QLD when I am long but choose PSQ (a 1X ETF) when short rather than QID. I have read countless commentary stating that the holding period for leveraged ETF's should only be a day or two. My experience, which is only with QLD, is much different. My typical holding period is 70 - 80 days and I am pleased with the results. That being said, leveraged ETF's aren't for everyone because the price swings are very wide and can be unsettling.

Nov 11 11:35 AM

[balois:]

I agree with Mr Fry
There must be some serious sour grapes among brokers. I am not sure this is accessible to US investors but I ve been using the Lyxor ETF XBear DJ Eurostoxx 50 (bloomberg BXX:FP) to hedge my stock portfolio for preservation - and it works perfectly. I ll intend to keep it, especially in these volatile times, even medium term, up to 3 to 5 years or so.

Have good day

Nov 11 12:49 PM

[predictorma...:]

Leveraged ETFs are a great way to play a short term (and this could be a week or two) "hunch". Unless you were a greedy ultrabull you took profits and/or got into cash at varying points in this rally "knowing" that the market was going down or sideways. David Fry's charts showed that this would happen at various points. Unfortunately nothing this year has gone the way it was supposed to, and many people missed the various upticks. Today's charts say the markets (fyi I like TNA, TZA for the lack of manipulation factor) could go up OR down. I'm thinking up, so I'm long.

Using a variety of metrics I get a sense of where a week is going and then go 3X long or short. Once I've got my profits I get out. It's the only strategy that has worked for me post July. Everything else goes up for a number of days, then loses it all, victim of the non-fundamentals market.

Nov 12 08:42 AM

[Aquater:]

Black box comments are of no help, for example, readers saying they made money using this or that instrument without revealing what they based their trades on. Of course they may want to keep it close to their chest but they need to realize that any loud mouth can bluff and brag like that on any instrument.
Much of so-called regulation on the leveraged ETF's seems made to satisfy various vested or entrenched interests of financial institutions. Just in plain language lay out what are the potential problems in trading them and then get out of the traders' way. In a nation which allows casinos and even state-sponsored lotteries and other gambling avenues it is scandalous that insulting paternalism never stops in the financial arena.
Instead of facilitating good education on personal finance and investing, financial institutions try to give advice that refuses to work because it is really designed to serve the needs of the institution itself rather than the consumer. Much of regulation is of this nature which smacks of culpable paternalism.

Nov 12 01:00 PM

[buyitcheap:]

What the heck happened to TNA on Friday 11/20? Closed Thursday at 40.17 opened at 35 and change!

Nov 21 11:48 AM

[Rb101:]

-dividend was issued, so repriced-same for a dozen other 3X ETF- it didn't drop 13% -charts should adjust for that on Monday...

On Nov 21 11:48 AM buyitcheap wrote:

> What the heck happened to TNA on Friday 11/20? Closed Thursday at
> 40.17 opened at 35 and change!

Nov 22 12:21 AM

[COCOJV:]

Hey guys where can I get info. about this:

What the heck happened to TNA on Friday 11/20? Closed Thursday at
> 40.17 opened at 35 and change!

Nov 22 11:21 PM

[fjpenney:]

Go to Yahoo Finance, get a quote on TNA and then look at the price history to see the dividend.


On Nov 22 11:21 PM COCOJV wrote:

> Hey guys where can I get info. about this:
>
> What the heck happened to TNA on Friday 11/20? Closed Thursday at

Nov 27 07:55 PM