What Are They?
- Like traditional sector ETFs, leveraged sector ETFs offer a simple way to get exposure to an entire US equity sector, weighted by market cap.
- But unlike traditional sector ETFs, these ETFs provide double the performance of a traditional index. So if the Dow Jones U.S. Utility Sector rises by 1%, for example, the ProShares Ultra Utilities ETF (NYSEARCA:UPW) would rise by 2%.
- Leveraged ETFs are able to do this by using by using options and futures contracts. Any funds not invested in them are deposited in a money market account or invested in bonds.
Why & How To Use Them
- Active traders can use leveraged ETFs to play short-run market movements. Since they have more volatility than a regular index fund, the potential for gain (and loss!) is larger.
- Longer-term investors can use leveraged ETFs to increase their exposure to an index without needing to borrow money on margin. For example, they can be purchased in retirement accounts which don't allow margin lending.
What to Look Out For
- Leveraged sector ETFs are riskier and more volatile than standard sector ETFs.
- They tend to have higher expense ratios than standard sector ETFs, even proportionate to the level of exposure. Also, the use of futures means that dividend income would be lower or non-existent.
- Leveraged ETFs perform poorly in flat markets, and can underperform their benchmarks in conditions of significant volatility.
- Sector indexes themselves have greater concentration than broader market indexes, and are therefore more volatile.
- Tristan Yates and Lye Kok discuss the risk that leveraged ETFs will produce sub-par long term performance in Leveraged ETFs: A Value Destruction Trap? and The Case Against Leveraged ETFs. Christopher Baldwin also comes out against leveraged ETFs in Clear Proof Against Leveraged ETFs.
- However, Brett Steenbarger shows in Are ProShares Ultra ETFs Used As Hedging Devices By Money Managers? that trading volumes for leveraged ETFs have grown strongly.
- Uses of leveraged ETFs are discussed in Leveraged ETFs For Upside Juice and Downside Protection and in Brad Zigler's Leverage and Inversion: A New Look for ETFs.
- For more discussion of sector ETFs in general, see Should You Use Sector ETFs?.
- Types of sector ETFs: Global Sector ETFs, Foreign Sector ETFs, Primary US Sector ETFs, Equal Weight Sector ETFs, Quant Strategy Sector ETFs, Fundamental Sector ETFs and Leveraged Sector ETFs.
- Leveraged ETFs also include Leveraged Market Cap ETFs and Leveraged Growth/Value ETFs.
This page is part of The Seeking Alpha ETF Selector which sorts ETFs by type, highlights how to use them and what to look out for, and provides links to articles that discuss key issues for investors.