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Leveraged ETFs: A 10-Minute Guide

By Zacks Investment ResearchETFsJun 23, 2015 11:21AM ET
www.investing.com/analysis/10-minute-guide-to-10-most-popular-leveraged-etfs-256005
Leveraged ETFs: A 10-Minute Guide
By Zacks Investment Research   |  Jun 23, 2015 11:21AM ET
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The U.S. bourses are once again hovering around their record highs irrespective of volatility and uncertainty. This trend is likely to continue at least in the short term since the looming rates hike is not expected anytime before late September or October, suggesting one more quarter of cheap money flows into the economy.

Additionally, a flurry of upbeat data including a strengthening job market, recovering housing fundamentals, rising consumer confidence and stepped-up economic activities will continue to drive the stocks higher. Further, lower oil price – the major threat to economic growth this year – has stabilized at the current levels (read: Equal Weight Energy ETF: A Better Way to Tap Oil Rebound?).

Meanwhile, the fixed income market doesn’t look too bleak as the Fed will raise interest rates more slowly than many expected, putting a cap on the falling securities world over. However, as the economy gains strong traction, long-term interest rates will rise at a faster rate, dulling the appeal for long-dated bonds.

That being said, most investors are willing to make a short-term play in the financial world given the cloud over the timing of the hike. For them, leveraged products might offer compelling investment avenues given the money that these mint in a very short period of time provided the trend remains a friend.

Leveraged ETFs Explained

Leveraged funds provide multiple exposure (i.e 2x or 3x) to the daily performance of the underlying index by employing various investment strategies such as swaps, futures contracts and other derivative instruments.

While this strategy is highly beneficial for the short-term traders, it could lead to huge losses compared to traditional funds in fluctuating or seesaw markets. Further, their performances could vary significantly from the actual performance of their underlying index over a longer period when compared to the shorter period (such as, weeks or months) due to their compounding effect (read: Understanding Leveraged ETFs).

How to Play?

Given this, investors should make a right selection of the leveraged ETFs in their portfolio with a strong belief that this trend will persist for a specific period at least. While there are currently over 130 leveraged ETFs in the market targeting different asset classes, we have taken a closer look at the 10 most popular funds for short-term investors.

Here’s a handy guide to these ETFs that are hugely popular but not otherwise the best choices in their respective markets:

  • ProShares Ultra S&P500 (ARCA:SSO)

Leveraged Factor: 2x

Benchmark Index: S&P 500 Index

This is the most popular and liquid ETF in the leveraged space with AUM of $1.9 billion and average daily volume of over 6.3 million shares a day. The fund seeks to deliver twice the return of the S&P 500 Index, charging investors 0.89% in expense ratio. It has gained 4.6% so far in the year.

  • Direxion Daily Financial Bull 3X Shares (ARCA:FAS)

Leveraged Factor: 3x

Benchmark Index: Russell 1000 Financial Services Index

This ETF seeks to make large profit from the bullish trend in the financial sector. It provides three times exposure to the performance of the Russell 1000 Financial Services Index. The fund has amassed nearly $1.3 billion in its asset base while trades in heavy volume of around 4.7 million shares. It charges 95 bps in annual fees and has gained about 8% in the year-to-date timeframe.

  • ProShares UltraPro QQQ (NASDAQ:TQQQ)

Leveraged Factor: 3x

Benchmark Index: NASDAQ-100 Index

Investors seeking to ride out the soaring Nasdaq in a very short period of time could make a play on TQQQ. This is because it provides three times the return of the daily performance of the NASDAQ-100 Index and exchanges around 3 million shares in hand on average. The fund has AUM of $1.1 billion and charges 95 bps in fees and expenses. It has surged 14.8% so far in the year (read: 3 Tech-Inspired ETFs to Ride the Nasdaq Bull).

  • ProShares Ultra QQQ (ARCA:QLD)

Leveraged Factor: 2x

Benchmark Index: NASDAQ-100 Index

This fund also tracks the NASDAQ-100 Index but offers twice the returns of the daily performance with the same expense ratio of TQQQ. It has managed AUM of $1 billion and sees just 0.5 million less in average daily volume. QLD had returned 13.8% in the year-to-date timeframe, 100 bps below its triple leveraged counterpart.

  • ProShares Ultra Bloomberg Crude Oil (ARCA:UCO)

Leveraged Factor: 2x

Benchmark Index: Bloomberg WTI Crude Oil Subindex

This fund provides leveraged play in the crude oil segment of the commodities market. It seeks to deliver twice the return of the daily performance of the Bloomberg WTI Crude Oil Subindex, which consists of futures contracts on crude oil. It has $934.7 million in AUM and trades in solid volume of more than 4.2 million shares a day on average. Expense ratio comes in at 0.95%. The ETF is down 9.6% in the year-to-date timeframe.

  • ProShares Ultra Nasdaq Biotechnology (NASDAQ:BIB)

Leveraged Factor: 2x

Benchmark Index: NASDAQ Biotechnology Index

Since biotech has been on a tear this year, BIB makes for an excellent pick for investors seeking to make large profits from this space in a short span. The fund creates a double leveraged long position in the NASDAQ Biotechnology Index while charging 95 bps in fees a year. It has $917.5 million in its asset base and sees solid volume of 4.2 million shares a day in average. So far this year, the ETF has returned a whopping 42.3% to investors (read: Intro Guide to Leveraged Biotech ETF Investing).

  • ProShares UltraPro S&P500 (ARCA:UPRO)

Leveraged Factor: 3x

Benchmark Index: S&P 500 Index

This product provides triple leveraged play to the S&P 500 index, charging 95 bps in fees and expenses. It has been able to manage $982 million in its asset base with daily trading volume of around 3 million shares. UPRO is up over 9% so far this year.

  • ProShares Ultra Financials (NYSE:UYG)

Leveraged Factor: 2x

Benchmark Index: Dow Jones U.S. Financials Index

This is another popular leveraged ETF in the financial space, having amassed $851 million in its asset base. UYG offers three times exposure to the daily performance of the Dow Jones U.S. Financials Index. The fund has added 5.5% so far in the year but the total cost is much higher than the expense ratio of 0.95%. This is primarily thanks to its moderate volume of under 86,000 shares a day which increases the total cost in the form of a wide bid/ask spread.

  • Direxion Daily Gold Miners Bull 3X Shares (NYSE:NUGT)

Leveraged Factor: 3x

Benchmark Index: NYSE Arca GoldMiners Index

This product seeks to deliver thrice the daily performance of the NYSE Arca Gold Miners Index, which consists of firms that operate globally in both developed and emerging markets, and are involved primarily in the exploration and production of gold. It is rich in AUM of $802 million and trades in heavy volume of nearly 18 million shares. Expense ratio comes in at 0.95%. The fund has delivered negative returns of 13% so far in the year thanks to the dulling appeal for gold and gold mining stocks.

  • VelocityShares 3x Long Crude linked to S&P GSCI Crude Oil Excess Return (NYSE:UWTI)

Leveraged Factor: 3x

Benchmark Index: S&P GSCI Crude Oil Index Excess Return

This is another popular leveraged fund targeting the energy segment of the commodity market through WTI crude oil futures contracts. It seeks to deliver thrice the returns of the S&P GSCI Crude Oil Index Excess Return and has attracted $788.5 million in its asset base. Though the fund charges a higher fee of 1.35% per year, its average daily volume is incredible exchanging about 54.4 million shares a day. UWTI is down about 28% so far this year but represents a solid opportunity when crude oil resumes its uptrend.

Bottom Line

Investors should note that ProShares has been the leader in the leveraged ETF space with most of the popular products coming from this issuer. These ETFs are not confined to one asset class or a specific sector but are spread out across various corners of the world. While equity-based products are gaining immense popularity, leveraged commodity ETFs are slowly gathering assets (see: all Leveraged Equity ETFs here).

With a steadily increasing stock market and bullish outlook, these funds could pile up abnormal returns in a shorter period of time.

Leveraged ETFs: A 10-Minute Guide
 

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Leveraged ETFs: A 10-Minute Guide

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