Back in August I wrote about some of the pros and cons of using Exchange Traded funds (ETFs) and investment trusts as an alternative to conventional mutual funds.
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One area of ETF investing that is often commented on by investors is the use of Leveraged ETFs. It’s not really surprising when you see returns of 80% over a 6 month period (leveraged Soybeans) and more recently Leveraged Silver has gone up nearly 40% in 4 weeks – it’s easy to see why they are fast becoming one of the most popular types of ETF. However they don’t achieve this without some controversy and before you make the decision to use them there are some basics to understand.
What Are Leveraged Exchange Traded Funds (Leveraged ETFs)?
Some of the most popular funds will be looking to produce 2 or 3 times the return of the correlating asset.
How Do Leveraged ETFs Achieve This?
In theory a 2x Leveraged ETF should create a 2% return if the index rises by 1% but there are other factors influencing the return.
If the ETF is only holding a selection of assets rather than a full replication of the index then this may reduce some of the dealing costs but this can add a level of active management that eventually produces a much larger tracking error.
Tracking errors of 10% are not uncommon which can of course get magnified in a leveraged fund.
Misconceptions Of Leveraged ETFs
A good example of this is Leveraged Tin which has produced a very desirable return of 21% in the past 4 weeks but over 12 and 26 weeks has struggled with -2% and -31% respectively. Based upon your timing in and out of that fund your eventual return could have been considerably higher or lower than these figures.
For our analysis of the ETF, Investment Trust and mutual fund market we have found the information in a regular publication called saltydog investor invaluable and definitely worth a look if you are considering making any investments. Check their website at www.saltydoginvestor.com