Short plays only
Holding leveraged and inverse ETFs too long distorts objectives
BOSTON (MarketWatch) -- The market rout in 2008 has exposed the dangers of leveraged and leveraged inverse exchange-traded funds, designed to capture two or three times the movement in a particular stock index or provide 100% opposite results, as investors learned the hard way about the tax and performance distortions inherent in the funds.
These relatively new financial products are "among the fastest growing segments of the U.S.-listed ETF market" with $21.6 billion in assets and $17.4 billion in average daily trading volume, Morgan Stanley analysts led by Dominic Maister wrote in a research note last week.
Leveraged and inverse ETFs are "appropriate tools for some investors looking to make short-term tactical trades if they perceive a high likelihood of a strong market move occurring in a relatively short time period," said Maister.
In other words, traders and speculators can get more bang for their buck if they're trying to exploit quick market swings. Of course, losses are also magnified when markets move against the trade.
However, the effects of compounding "and the daily re-levering or de-levering that occurs within leveraged and leveraged inverse ETFs can lead to unexpected results over the long-term," Maister said. Investors probably don't want to hold leveraged and inverse ETFs more than a few days, experts warn.
The key point is that these ETFs provide leverage on a daily basis. Simply, investors are mistaken if they think they can buy a twice-leveraged ETF, hold it for a year, and end up with double the market's return.
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