According to Vanguard's research, the S&P 500 index experienced an average 2.5% move, either up or down, every day through August following the U.S. debt downgrade. ETF trading volumes also spiked during this bout of market volatility.
Vanguard, though, argues that volatility, on average, should have been shifting upward over time if the rise in overall market volatility were the direct result of changes by market participants. However, data does not show any historical upward shifts in volatility levels-volatility remained stable and low before S&P's August 5 downgrade of the U.S., but jumped after significant global macroeconomic distress appeared. Vanguard emphasized that the recent market fluctuations were ordinary during past periods of similar uncertainty.
Understanding Leveraged ETFs
ProShares launched the first set of leveraged ETFs back in June 2006. The funds used equities and other financial products, including derivatives such as options and futures contracts, to mimic leveraged returns.
Since trading an ETF is a quick and easy method of investing, ETF investors who seek additional exposure to specific areas of the market may benefit from the leverage strategy instead of relying on options, futures or margins. Leveraged ETFs may help investors capture short-term gains and hedge current positions in portfolios, and they can also be used in a pairs trading strategy.
ETFs that offer a leveraged strategy rebalance regularly to achieve their intended leverage targets. Most leveraged ETFs adhere to a daily reset, and as a result of the daily rebalancing, the multiple-day return will not perfectly reflect a 2x or 3x performance of the underlying index. Because of compounding, leveraged ETFs show deviations from their net asset values over the long term as the funds adhere to their regular rebalancing. Additionally, the daily reset ETFs may underperform during highly volatile situations and outperform in times of low volatility.
Some other leveraged products do not reset every day but may reset after a certain number of days. The ETFs will try to reflect the stated leverage at trade multiplied by the total return of the underlying benchmark: A fund might reflect two times or three times the performance of an underlying benchmark over a certain period. For instance, some leveraged ETFs will rebalance holdings monthly. However, this type of leveraged fund will stop trading and will be recalled at the ending net asset value if the NAV dips below a predefined point.
Leveraged Fund Providers
ProShares is the largest provider of leveraged ETFs. It offers leveraged funds that cover most of the largest asset classes, sectors and sub-sectors. Direxion also offers a large suite of leveraged funds that cover U.S. and global equities, along with some Treasury bonds.
ETRACS offers a few leveraged exchange-traded notes.
FactorShares offers some unique strategies on leveraged long/short ETFs that hold a leveraged long position in one asset and short the assets of another, which helps the funds capitalize on the spread between the two assets.
Invesco PowerShares has issued a couple of leveraged Treasury-related ETNs.
Rydex has a leveraged/inverse S&P 500 ETF.
VelocityShares provides leveraged short- and medium-term VIX ETFs.
Tom Lydon is editor and publisher of ETF Trends, a Web site with daily news and commentary about the fast-changing trends in the exchange-traded fund (ETF) industry. Lydon is also president of Global Trends Investments, an investment advisory firm specializing in the creation of customized portfolios for high-net-worth individuals. Disclosure: At the time of publishing, Mr. Lydon's clients owned IndexIQ Agribusiness Small Cap ETF (NYSEArca: CROP).
Read the disclaimer; Tom Lydon is a board member of Rydex|SGI.