... Leveraged ETFs

In the past we whole-heartedly endorsed leveraged ETFs. (FD: we are heavily invested in two leveraged products - UYG and HOU.to) For those who are not familiar with the product, these ETFs attempt to replicate performance of an underlying index improved by a certain factor. There are two main categories of ETFs out there: Accelerated or Bull (2x, 3x and now even 100x) and Inverse or Bear(-1x or -2x).

We are no longer fans of the product and looking to off-load all of our holdings. And we definitely do not recommend it to anyone with longer than daily investment horizon. The reason for that turned out to be in the small print of their prospectuses. You see, the funds attempt to enhance only daily movements of the index. And that does not translate into any kind of predicatble long-term impact. For that matter, the impact is not correlated with the underlying index. ProShares' website (one of the purveyors of the product) and prospectus now bear a warning that “in the periods of high volatility the results will tend to exaggerate negative trends” (but not positive).

Our original logic behind recommendation was the obvious benefit of leveraging: if, over the long term, major broad indices return around 10%, the leveraged position should return 20%, as long as the investor is comfortable with temporary set backs.

It is now obvious that the aforementioned funds do not serve that purpose. It is interesting to compare performances of two funds that were meant to be mirror images of each other – ProShares’ Bull and Bear Dow Financials (UYG and SKF). Over almost any somewhat long-term period (12 months and up) both of them had negative returns. Counterintuitive? It still is to us. Furthermore, if you were to invest into its non-leveraged cousin iShares’ IYG, your returns would have been much more superior to either one of them.



This chart on Yahoo!Finance

Same chart on Google Finance

However, we are still very much on board with ETF investing in general (for its ability to deliver diversity at a low cost) and leveraging (for its ability to enhance the results). Leveraged ETF however deliver none of the above.