Investors who hold leveraged and inverse ETFs for periods longer than one or two days expose themselves to substantial risk that the holding period returns will deviate from the returns to a leveraged or inverse investment in the index they replicate, according to a study issued by Securities Litigation and Consulting Group Inc. (SLCG) on Monday, August 30.
In the new study, "Leveraged ETFs, Holding Periods and Investment Shortfalls," authors Ilan Guedj, Guohua Li and Craig McCann expand on research that argues that leveraged and inverse ETFs do not deliver the returns investors may expect when they invest in them for period of more than one or two days. They note that FINRA has required the issuers of leveraged and inverse ETFs to caution their customers that these funds should be short-term investments and need to be monitored carefully.
The SLCG researchers found that many investors hold their leveraged ETFs for long periods, sometimes more than three months. They calculated the shortfall of this behavior compared to creating the leverage in a margin account. Some ETF investors lose up to 3% of their original investment in just a few weeks, the equivalent of a 50% annualized return, they found.
"This indicates that investors do not fully understand the risks associated with inappropriately using leveraged and inverse ETFs as long-term investments," they write in the study.
Guedj, Li and McCann also investigated the value added to the marketplace by ETFs that rebalance monthly instead of daily. They found that the average investment shortfall, though smaller, is still significant. Moreover, although they found that less frequently rebalanced leveraged and inverse ETFs tend to have returns that are more similar to investing in a margin account, these may add risk because their leverage can vary significantly from day to day.
Michael S. Fischer (firstname.lastname@example.org) is a New York-based financial writer and editor and a frequent contributor to WealthManagerWeb.com.