For real-time updates, do join our:
- Telegram Group: t.me/theinvestquest (or search “The InvestQuest” on Telegram)
- Whatsapp Broadcast: Just send “Hello IQ” to +65 8840 2520
- Facebook Page: The InvestQuest | Facebook
- LinkedIn Page: The InvestQuest | LinkedIn
Difficulty Level: Moderate
1) When should you use Leveraged ETFs?
3x Leveraged ETFs may not give you 3x the Index Return. The S&P 500 Index is UP 4.9% year-to-date (as of 9 August), while the 3x Leveraged S&P 500 ETF is DOWN 19.7% during the same time period.
2) “Leveraged ETFs” versus “Leveraging on Normal ETFs”
We compared the performance of a Leveraged S&P 500 ETF, vs. leveraging up (i.e. share financing) to buy an Unleveraged S&P 500 ETF.
3) The Ultimate List of Leveraged Stock ETFs
We’ve compiled the Ultimate List of Leveraged Stock ETFs. Where there was more than one option available, we selected the ETF which had a combination of the largest market cap, lowest total expense ratio, highest daily traded volume, and tightest bid-ask spread.
The InvestQuest’s View: Leveraged ETFs are best used for short-term trading, or if you think that the market is riding a price trend with very low volatility. If you want levered returns but expect periods of high volatility, Leveraging on NORMAL ETFs is better than using Leveraged ETFs.
If you find this article useful, do feel free to check out our other ETF and Mutual Fund related articles too!
- Ultimate Stock ETF List for SG Investors
- SGX-listed Stock ETFs: Which are good enough for our readers?
- SGX-listed Bond ETFs: Which are good enough for our readers?
- Best ETF to buy for China Stock Exposure
- China Tech: The best ETFs and Stocks to invest in
- When to use Active Mutual Funds vs Passive ETFs
- Ultimate List of Mutual Funds for SG Investors
A Leveraged Exchange-Traded Fund (ETF) uses financial derivatives (such as options or equity swaps) and debt to amplify the returns of an underlying index. It is common to find Leveraged ETFs that track 2x or 3x the daily performance of a stock index.
For example, if S&P 500 Index is up 1% in a day, the ProShares UltraPro S&P 500 ETF that tracks 3x the daily performance of the S&P 500 Index will be up by approximately 3% on that same day.
Conversely, a leveraged INVERSE ETF makes gains when the underlying index DECLINES in value.
3x Leveraged ETFs may not give you 3x the Index Return.
- “S&P 500 Index” is UP 4.9% year-to-date as of 9 August…
- But 3x leveraged “ProShares UltraPro S&P 500 ETF” is DOWN 19.7% over the same time period.
We illustrate when you should use Leveraged ETFs using the examples below:
- Case 1: A volatile market that ends flat
- Leveraged ETFs DO NOT work well in volatile markets that trade within a range.
- Case 2: Steadily uptrending market
- Leveraged ETFs work well in steadily uptrending markets, as prior gains will compound.
- Case 3: Steadily downtrending market
- Leveraged ETFs lose less in steadily downtrending markets, as new losses will be compound on a smaller base.
Case 1: A Volatile Market that Ends Flat
We look at scenario where the stock index is very volatile but ends with a flat return over the course of 4 trading days. The intention of this is to show how the math will work to derive the ending price of the 3x Leveraged ETF.
In this case, the 3x Leveraged Index ETF would have ended the four days at 56% of its original price, despite the Stock Index ending flat!
TAKEAWAY: Leveraged ETFs DO NOT work well in volatile markets that trade within a range.
Case 2: Steadily Uptrending Market
In the scenario below, the index ends 20% higher after four days.
Meanwhile, the 3x Leveraged ETF gains 68.83% over four days. This is more than 3x the Index’s 20% return over the same period.
TAKEAWAY: Leveraged ETFs work well in steadily uptrending markets, as prior gains will compound.
Case 3: Steadily Downtrending Market
In the scenario below, the index ends 20% lower after four days.
Meanwhile, the 3x Leveraged ETF loses 50.88% over four days. This is LESS than 3x the Index’s 20% decline over the same period.
TAKEAWAY: Leveraged ETFs lose less in steadily downtrending markets, as new losses will be compound on a smaller base.
Quick Caveats to the Takeaways
What we have done is a very simplistic way to look at the performance calculation of Leveraged ETFs. In reality, there are additional costs that may weigh down on the performance of Leveraged ETFs, including:
- ETF management fees
- Interest-related expenses to maintain the leverage effect
- Transactional fees incurred in daily rebalancing of the ETF portfolio
In short, Leveraged ETFs are best used for short-term trading, or if you think that the market is riding a price trend with very low volatility.
Over the long-term, there doesn’t seem to be a clear winner between the two options. Periods where there is a clear outperformance of either option depend heavily on the market volatility during that period.
Between 2012 and 2014, when the market was very steadily uptrending, the “Leveraged ETFs” outperformed “Leveraging on a NORMAL ETF”.
In 2020, when the market sold off heavily in March before rebounding sharply, “Leveraging on a NORMAL ETF” would have outperformed using “Leveraged ETFs”.
We’ve compiled the Ultimate List of Leveraged Stock ETFs. Where there was more than one option available, we selected the ETF which had a combination of the largest market cap, lowest total expense ratio, highest daily traded volume, and tightest bid-ask spread.
Leveraged ETFs for Sector Exposure
The ETFs below are categorized primarily by sector exposure and specific region if applicable.
Further details on each of these ETFs such as total expense ratios, average trading liquidity, bid-ask spreads and ETF replication method may be found in APPENDIX 1.
Leveraged ETFs for Regional Exposure
The shortlisted ETFs below are categorized by the geographical stock exposure they offer.
Further details on each of these ETFs such as total expense ratios, average trading liquidity, bid-ask spreads and ETF replication method may be found in APPENDIX 1.
The InvestQuest’s View: Leveraged ETFs are best used for short-term trading, or if you think that the market is riding a price trend with very low volatility. If you want levered returns but expect periods of high volatility, Leveraging on NORMAL ETFs is better than using Leveraged ETFs.
APPENDIX: More Details on Selected ETFs
In some cases, it was not possible/easy to find an ETF that was good in all cost-related aspects. We highlighted those less-than-optimal traits in red, in the below tables. These traits included:
- Market cap of less than USD 200 million.
- Total expense ratio of more than 0.75%
- Daily average trading volume below USD 3 million
- Bid/ask spread of more than 0.3%
- ETF Replication Strategy that uses Derivatives (as opposed to a physically backed ETF)
Do note that to add the leverage feature, all the ETFs shown are constructed using derivatives. This adds an additional element of counterparty risk compared to ETFs that are physically backed by shares.
If you find this article useful, do feel free to check out our other ETF and Mutual Fund related articles too!
- Ultimate Stock ETF List for SG Investors
- SGX-listed Stock ETFs: Which are good enough for our readers?
- SGX-listed Bond ETFs: Which are good enough for our readers?
- Best ETF to buy for China Stock Exposure
- China Tech: The best ETFs and Stocks to invest in
- When to use Active Mutual Funds vs Passive ETFs
- Ultimate List of Mutual Funds for SG Investors
2 Trackbacks / Pingbacks