Proposed FactorETFs: Leveraged Investing with a Twist

by: Michael Johnston

There can be little argument that ProShares and Direxion have established themselves as the dominant providers of leveraged ETFs in the U.S.

But New Jersey-based FactorETF Trust may be making a push into their territory, offering a whole new breed of leveraged exchange-traded products. The proposed ETFs would seek to provide 200% of the daily return of an underlying benchmark, similar to existing funds.

But instead of being based on static equity and bond indexes, the funds’ target returns would be based on the performance of a target sector or asset class relative to the broad markets (or even relative to more specific benchmarks).

For example, the FactorETF 2x Value Factor Shares would seek returns equal to 200% of the daily excess return of U.S. value stocks over U.S. growth stocks. The other “matchups” proposed in the FactorETFs filing include:

  • Small vs. large capitalization equities
  • Momentum vs. reversal equities
  • U.S. developed vs. non-U.S. developed
  • Emerging markets vs. non-emerging markets
  • Financial sector vs. broad market
  • Energy sector vs. broad market
  • Technology sector vs. broad market
  • REIT vs. equities
  • U.S. equities vs. government bonds
  • Short duration government bonds vs. long duration government bonds
  • Corporate bonds vs. government bonds
  • TIPS vs. nominal government bonds

In all, FactorETF is asking approval for 23 funds. With many of the “matchups” mentioned above, the issuer is proposing two funds (e.g., there is both a Large Factor ETF that tracks excess return of large cap stocks over small cap stocks and a Small Factor ETF that tracks the excess return of small cap stocks over large cap stocks).

In order to achieve their stated investment goals, the proposed ETFs would use a variety of complex strategies and instruments, including long/short investing and an array of derivative products.

As such, the FactorETF products will likely be geared towards sophisticated investors who have intended holding periods of only a few hours. In recent months, leveraged ETFs have been the subject of great scrutiny from a number of regulatory agencies.

Most recently, FINRA conducted a data sweep of leveraged ETF issuers to determine the extent to which leveraged products are being used inappropriately (i.e., being held for multiple trading sessions).

From that perspective, the timing of the FactorETF filings is interesting, and I’ll be very interested to see how the SEC responds.

Disclosure: No positions at time of writing.