Using Leveraged and Inverse ETFs to Manage Market Risks

With the bull market in stocks now almost twice as long as average and interest rates on the cusp of heading higher this year or next, it’s not surprising that investors would be attracted to leveraged and inverse exchage-traded funds. They have the potential to magnify potential gains in the underlying long or short index.

If the S&P 500 index moves only slightly higher, a leveraged S&P 500 ETF will gain two or three times as much, depending on the particular ETF. If long-term rates rise, an inverse ETF like TMV, which sells short the NYSE 20-Year Plus Treasury bond index — can reap three times the gains of selling short the index.

“One dollar gives you three dollars’ worth of exposure,” said Michael Eschmann, a managing director at Direxion Investments, one of the largest issuers of inverse and leveraged ETFs. He was one of several presenters at this week’s webinar “Building Tactical Strategies to Combat Today’s Market Challenges,” sponsored by ETF Trends, which covers the changing ETF market.

But these ETFs are not for everyone. “They’re not suited for conservative investors or investors who cannot tolerate substantial losses for a short period of time,” said Eschmann. “And they’re not for long-term investors who don’t monitor portfolios frequently.”

Indeed, the retail client version of Schwab Intelligent Portfolios (SIP), an ETF-based robo-advisor, includes no leveraged ETFs. “These instruments are not meant to be bought and held,” said Sharon Snow, CEO of Metropolitan Capital l Strategies, a Reston, Virginia-based SEC-registered investment advisor. “If you use them tactically, you can use them at certain points in time.”

She uses leveraged ETFs and holds them from about one to three months, rebalancing on a rolling balance, including the Direxion Daily Healthcare Bull 3X ETF (CURE) for health care, the Direxion Daily Technology Bull 3X ETF (TECL) for technology, and the similarly named Direxion 3X funds EDC for emerging markets and ERX for energy.