Key facts
- Over 400 of 700 US leveraged ETFs have launched in the past two years, managing roughly $200 billion.
- Leveraged ETFs use debt to double or triple daily performance, but daily resets can cause significant losses due to 'volatility decay'.
- South Korea has banned new leveraged ETFs and increased requirements for existing ones due to concerns about market volatility.
- The ProShares UltraPro QQQ, a leveraged ETF tracking the Nasdaq-100, has shown significant long-term returns, though this is seen as an anomaly.
- Leveraged ETFs are criticized for encouraging speculative 'portfolio gambling' among retail investors rather than long-term investment.
Leveraged Exchange-Traded Funds (ETFs), designed to amplify daily stock or index performance by two or three times, are experiencing a surge in popularity, with over 400 new products launched in the last two years, now managing approximately $200 billion in assets.
These instruments, while offering the allure of doubled or tripled returns for investors with strong convictions, carry significant risks. Experts like Gene Goldman, chief investment officer at Cetera Advisors, caution that investors often misunderstand the daily reset mechanism, which can lead to rapid wealth erosion through 'volatility decay,' even if the directional bet on the underlying asset is correct. Brent Coggins, CIO of Triad Wealth, highlights that this decay can quadruple losses with 2x leverage and multiply them up to nine times with 3x leverage.
The amplified volatility associated with these ETFs has directly contributed to historic stock market swings in South Korea. In a swift reversal, the South Korean government announced it would halt new leveraged ETF approvals and increase investor requirements, with regulator Lee Chan-jin expressing regret over their initial authorization. The rapid influx of capital into these products, which accounted for up to 35% of stock turnover on certain days, exacerbated volatility in a market already concentrated in major tech stocks like Samsung and SK Hynix.
While sponsors and investment banks profit from these products through fees and swap agreements, critics like Goldman view them as 'trading tools' rather than investments, likening them to 'portfolio gambling' that can turn a sound conviction into a lottery ticket, particularly for retail investors. Coggins attributes their appeal to 'herd mentality' and a desire for windfalls, drawing parallels to past investment booms in crypto and commodities.
Despite the risks, proponents point to the exceptional long-term performance of ETFs like the ProShares UltraPro QQQ, which has returned over 32,000% since its inception. However, this performance is largely attributed to a unique market environment and the diversification of the Nasdaq-100 index over 15 years, rather than the inherent nature of leveraged ETFs. Coggins himself acknowledges the charts are tempting but notes that drawdowns of up to 80% would have made it nearly impossible for most investors to stomach holding the ETF.