ET

Leveraged ETFs

Leveraged ETFs use financial leverage (ie. borrowing) to achieve their desired level of exposure to the underlying index.

• This means that they borrow money to invest in derivatives that deliver two or three times the daily return of the index. The returns from these investments are then combined with the ETF’s own assets to deliver the leveraged return.
  • the problem here is that compounding is introduced into the equation for calculating return. Compounding occurs when the returns from an investment are reinvested, leading to exponential growth over time.

Leveraged ETFs returns are amplified through the use of financial leverage (ie. using derivatives)

• ex. options and futures

Decay

With Leveraged ETFs, returns can diverge significantly from what we might expect based on the performance of the underlying index.

• in other words, just because QQQ returns 2% YoY doesn't mean TQQQ (a 3x leverage ETF based on QQQ) will return 6%.