What Is a Technology ETF?

Leveraged ETFs are an innovation over traditional ETFs. Traditional ETF usually refers to a listed and traded open-end fund that tracks the target index completely passively and pursues the same returns as the target index. When the index goes up, the value of the ETF goes up, and when the index goes down, the value of the ETF goes down. After more than ten years of rapid development, traditional ETFs have been widely recognized by the market. With the development of the financial derivatives market, overseas developed markets have begun to use ETFs, such as stock index futures and swaps, to achieve leveraged investment effects, that is, leveraged ETFs.

Leveraged ETF

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The positive and negative leveraged ETF, as the name suggests, is to realize the leveraged return of the investment portfolio relative to the tracking index within a set period of time. The primary significance of the leveraged ETF is that it successfully connects the two markets of securities and futures, which is conducive to promoting the two-way prosperity of the securities spot market and the stock index futures market, enhancing the liquidity and price discovery functions of A shares, and filling the market gap.

Leveraged and reverse ETFs use derivatives. Like short sellers, investors in reverse ETFs profit when stock prices fall, so this investment can be used as a hedging tool for the overall stock portfolio. At the same time, leveraged ETFs can allow investors to obtain returns that are equivalent to double or even triple the benchmark index's increase-of course, the amount of losses will also double.

The so-called double leverage index, in theory, when the index it tracks increases by 1%, its increase should be 2%; the reverse index is when the tracking index falls by 1%, the reverse index increases by 1%. From the perspective of the development of the international ETF industry, leveraged ETFs and inverse ETFs are the two most popular ETF developments. By amplifying and reversing the net value fluctuations of ETFs, it is possible for investors to use ordinary cash accounts for short and leverage transactions. The size of the reverse fund SDS listed in the United States tracking the S & P500 index reached US $ 1.56 billion, with an average daily trading volume of US $ 480 million; while the double leveraged fund that also tracked the S & P500 index had an SSO size of US $ 1.28 billion, with an average daily turnover of US $ 549 million.

However, it must be pointed out that the so-called doubling effect created by these levers is only short-term effective, and in the long-term, it cannot imitate the returns including compound interest and other factors. In fact, this is also one of the easiest investor illusions about these ETFs, which are likely to be extremely shocking.

Leveraged and reversed products are actually designed for short-term holding. Therefore, they naturally have amazing turnover. It is not surprising that they are the most active products among all ETFs.

It is also not necessary to make a fuss that this extremely volatile product may appear on both the best-performing and worst-performing lists. For example, at the beginning of 2009, due to concerns about the global economic outlook, causing crude oil prices to fall, leveraged reverse oil crude oil ETFs and ETNs rose alarmingly. ^[3]

Among non-traditional ETFs, leveraged ETFs and inverse ETFs together account for 80% of the total size and occupy a dominant position. As the name suggests, a leveraged ETF is an enlargement of the underlying index's fluctuations. For example, a leveraged ETF that tracks twice the S & P 500 index. If the S & P 500 index rises (falls) 1% on the day, the leveraged ETF will Up (down) 2%.

The design goal of an inverse ETF is to obtain the opposite return of the underlying index. For example, an inverse ETF with the S & P 500 index as the tracking target. If the S & P 500 index goes up (down) by 1% on the day, then the The ETF will fall (up) by 1%. In terms of fund management, non-traditional ETFs are more complicated than traditional ETFs. In addition to the need to invest in the constituent securities of the underlying index, non-traditional ETFs often use derivative financial instruments such as index futures and swap contracts to achieve leverage, counter Equal income effect.

Take the US market as an example. Although the traditional ETF was launched in 2002, the first leveraged ETF and inverse ETF did not appear until 2006. Compared with traditional ETFs, non-traditional ETFs have a shorter history and market share. According to Morningstar data, as of February 2013, there were 1,448 ETFs in the US market, of which only 262 were leveraged ETFs and reverse ETFs. 18% of the total number of ETFs. In terms of asset size, leveraged and inverse ETFs are only $ 31.2 billion, accounting for only 2.2% of the total $ 1.4 trillion in ETFs.

Non-traditional ETFs, represented by leveraged ETFs and inverse ETFs, are featured niche products. What are the characteristics worthy of investors' attention? What impact do these characteristics have on risk and return in investment?

1. First, the tracking returns of leveraged ETFs and inverse ETFs are calculated on a daily basis. This feature is more suitable for short-term trend judgment and hedging investment strategies, and may not be suitable for long-term investors. When investors have a clear judgment on the market trend or need to reduce risk exposure, they can execute investment strategies through leveraged ETFs and inverse ETFs. But for investors with long-term holding goals, using leveraged ETFs and inverse ETFs may not be suitable.

The reason is that such ETFs track the daily returns of the target index. If the investment period is prolonged or the market is volatile, the long-term returns of leveraged ETFs and inverse ETFs may gradually drift away from investment expectations under the effect of compound interest. For example, from 2007 to 2012, the S & P 500 Index increased slightly by 0.06%, which is almost a zero return, while the ETF (ProsharesUltraShortS & P500), which tracks the S & P 500 Index in the opposite direction, fell by 45% over the same period! Therefore, unless Often closed positions, long-term holding of leveraged ETFs or inverse ETFs is difficult to achieve the expected level of risk returns.

2. Second, the liquidity of non-traditional ETFs will directly affect the feasibility and investment effect of investment strategies. For non-traditional ETFs such as leveraged ETFs and reverse ETFs, the impact of high volatility and low liquidity cannot be underestimated. Taking leveraged ETFs as an example, since leverage has magnified the multiples of the underlying index's returns, it has also magnified the risk of investment. If the strategically required transactions cannot be completed in time, the potential losses will also be magnified.

The daily transaction amount of leveraged ETFs and reverse ETFs in the market accounts for an average of 7.5% of its asset size, but the distribution is not even. The most active DirexionDailyFinancialBull3x leveraged ETF can reach 46.6%, while the least active ProSharesShortSmallCap600 reverse ETF has only 0.14%. Therefore, liquidity risks may limit the effectiveness of non-traditional ETFs as investment vehicles.

3. Third, due to the complicated management of non-traditional ETFs such as leveraged ETFs and reverse ETFs, the corresponding rates are generally higher than traditional ETFs. According to statistics from Morningstar, the average rate of leveraged ETFs and inverse ETFs in the US market is close to 1%, which is much higher than the average rate of traditional ETFs of 0.5%. High rates will directly affect investor returns. In addition, the frequent liquidation mentioned above will also increase the transaction cost of the investment. ^[4]