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.
Eschmann suggested that investors with leveraged ETFs “have a daily investment objective” to follow.
He uses the TMV ETF for about 5% of bond portfolios to hedge against a rise in interest rates. “A spike in interest rates is a key theme for advisor strategies,” said Eschmann. “For investors, managing duration is very important.”
Duration measures the sensitivity of a bond to a 1% change in interest rates. The higher the duration, the bigger the change. “TMV has a negative 54 duration,” explained Eschmann. “A little bit goes a long way.” In contrast, the duration of a 30-year Treasury bond is roughly 21.
Of the more than 340 advisors who responded to a poll during the webinar more than 75% expected the 10-year Treasury yield will be 2% or higher a year from now. It’s at 1.95% currently. Thirty-five percent expected rates would top 2.2% by then.
Despite concerns about where markets are headed, leveraged and inverse ETFs remain just a fraction of the growing ETF market. At the end of the first quarter, leveraged and inverse ETFs accounted for about $42.6 billion in assets — slightly more than at the end of the first quarter of 2014 but only about 2% of total U.S. ETF assets, according to ETF.com.
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