These numbers are surprising! – words of caution to buyers of leveraged ETFs for anything more than a day-trade. Barron’s is catching up to Adam at Daily Options Report. Read the full Barron’s article, One-Day Wonders, if you’re confused about the calculations for the apparently absurd results.![[sc.png]](http://3.bp.blogspot.com/_dFwaKOYqt-A/SXNTcBElBJI/AAAAAAAAFfM/hD6CcN61HVg/s1600/sc.png)
– Ilene
Better Late Than Never
Courtesy of Adam Warner at Daily Options Report
Barron’s discovers something about Leveraged ETF’s.
SUPPOSE YOU HAD PREDICTED — correctly, as it turned out — that the Chinese economy would slow following last summer’s Beijing Olympics, causing China’s stock markets to tumble. Also suppose that, to profit from your insight, you had invested in the ProShares UltraShort FTSE/Xinhua China 25 , a leveraged exchange-traded fund (ticker: FXP) designed to go up by as much as twice the percentage that the FTSE/Xinhua China 25 Index falls on a given day.
When Chinese stocks crashed by 34% over the following four months, shouldn’t you have reaped a gaudy return around 68%? Not exactly. In fact, you would have lost 56%. How can this be? FXP message boards recently were filled with stupefied investors using colorful language to express their bewilderment. They blamed everything from currency fluctuations to tracking error.
A ProShares customer-service representative had the real answer: The performance of some leveraged funds, including China UltraShort, is based on only the daily performance results of the underlying index, not long-term returns. The problem: diverging base-index values. Once an index rises or falls and a leveraged ETF moves in the opposite direction, they no longer share their original mathematical relationship. Relative performance doesn’t hold after that first day.
…….What’s the lesson here? Investors seeking to profit from leverage might be better off doing it the old-fashioned way, by opening a margin account and buying or short-selling twice the amount of stock. There are dangers here, too, of course, and shorting stock is probably something only sophisticated investors should attempt. But at least investors would get the kind of performance they are paying for. With leveraged funds, in contrast, investors may get baffling long-term results that will leave them ultra-disappointed.
There’s nothing wrong with this piece, save for forgetting about a small distribution in FXP. But let me put it this way, I came to this same revelation about leveraged ETF’s back in June last year, and was embarrassed it took me that long to discover it. In all fairness however, I had just started trading them at the time.
But truthfully, you still see evidence the lessons here have not hit home. I heard a bond "expert" on TV recommending investors buy TBT to play for the expected rise in long term interest rates. Now bonds are not as volatile as Chinese stocks, so TBT will act better than FXP. But it’s still a lousy investment, these Leveraged Monsters are designed as trading vehicles. Period.
Oh and one other thing not related to the Barron’s piece, there is no such thing as "Leveraged ETF X" is cheap here. It’s purely a mathematical construct, the NAV of a leveraged ETF is fair relative to the underlying, at all times, whatever absolute price you see on the board. And the levered ETF is only high or low relative to it’s NAV. If you think Real Estate stocks are low or high or whatever, fine, but that’s a different conversation from saying SRS looks cheap.
Adam’s Source: One-Day Wonders, in Barron’s, by Tom Eidelman.
