Leveraged ETFs are designed to provide investors with a certain percentage return over the movement of a market over the span of a day. Inverse funds are supposed to move in the opposite direction of a specific index, to provide protection against declines.
The problem with these types of funds, is their use of borrowed money to magnify their bets also magnifies risk. The category has seen $2.8 billion in net inflows so far this year through mid-June, according to ETF.com, a research firm.
David Nadig, director of research at ETF.com says, “Many of these ETFs use “total return swaps”, a complicated financial agreement that allows a fund to take on leverage to boost returns. That adds a “counterparty” risk if the investment bank issuing the swap goes bust”.
Mr. Lee, Morningstar’s ETF analyst, says leveraged ETFs are aimed at day traders, who are constantly changing their portfolios and can take on more risk. “It’s not something you can buy and just forget about,” Mr. Lee says.
“If you want to make a strong bet on stocks, for example, you can invest in small stocks with a greater potential upside,” Mr. Lee says.