Leveraged ETFs, or exchange-traded funds, have been getting a bad rap from certain quarters of the finance world. Larry Fink of BlackRock Inc is quoted as saying that ETFs could “blow up the whole industry, while others say they are not appropriated for most investors. Also known as Geared ETFs, these funds are created to reward investors with some multiple, such as 2x or 3x, of the positive (and also negative) daily payoff of a referenced index. The two big hesitations many observers have about these investment vehicles are that they are not a good fit for investors who prefer to buy and hold their stocks over the long haul; and on the macro level, the effects these vehicles could have on markets have the potential of being destabilizing.
A new study investigating these issues asserts that these fears are most likely exaggerated. Co-authored by Ivan Ivanov and Stephen Lenkey, and entitled “Are Concerns About Leveraged ETFs Overblown?” the study concludes that the money going in and out of the funds “diminish the potential for leveraged and Inverse ETFs to exacerbate volatility.”
According to the research, the extreme ETF volatility created by the compounding effects of a factor of three ( or negative three) times the day’s return of an index can indeed make the ordinary investor sweat, the overall effect on the market, the supporting stocks and underlying index, is controlled.
A leveraged exchange fund still might not be for ordinary investors. One major issuer of ETFs, Michael Sapir explained that “the understanding in the market for these products has matured significantly,” since they first came on the market. Sapir added that geared investment risk might not be for everyone. “But institutions and financial professionals can use them to enhance return and manage risk.”