All About Leveraged ETF's

The traditional bonds and stocks are less appealing for the brave investor looking to increase their investment's performance. These investors are meticulous and ambitious and prefer an alternative investment vehicle called 'leveraged ETF', or leveraged exchange-traded funds.

What is a leveraged ETF?

Let's first review what an ETF actually is before we get into the details of a leveraged ETF. An ETF is a group of securities that are similar in nature and which can be traded on the stock exchange. An example of an ETF that is pharmaceutical in nature would be stocks from companies that are involved in the research and manufacture of pharmaceuticals.

What is the "leverage" bit and why is it so important?

A leveraged ETF is similar to an ETF and tracks the performance of the benchmark index or asset class. It increases the returns by using derivatives and debt instruments such as options, futures, swaps, reverse-repurchase agreements, and others.

The pros and cons of investing in leveraged ETFs

Leveraged ETFs are just like other investment vehicles. They also have their fair share of pros. Let's take a look at both.

The pros and cons of investing in leveraged ETFs

1. Margin borrowing is not necessary

Imagine a keen investor who believes the gold price will rise rapidly and would like to invest in an ETF. They lack the funds to do so. They would likely have borrowed against collateral from their broker to cover the cost of this loan. If they suffered losses from their investment, they would have lost the principal amount and would also have to surrender their collateral. Leveraged ETFs are a great way to save the investor money. The principal investment amount is not lost by the investor.

1. High liquidity

You can quickly withdraw your investment to get the cash you need. This is a great option if you have an urgent cash flow need. This is in contrast to long-term investments, where your funds cannot be converted into cash.

1. Accessible

Retail investors have difficulty accessing assets such as real estate. However, a leveraged ETF allows them to access alternative investments with minimal investment.

1. Amplified returns

If the index rises, the investor could receive as much as 3 times their investment. This is why leveraged ETFs are attractive to niche investors and traders.

The cons of investing in leveraged ETFs

1. High cost ratio

Leveraged ETFs are actively managed, which requires a lot of research and professional insight. A fund manager often charges a higher management fee than an unleveraged ETF. In the event of a profit, this can reduce the investor's returns.

1. There is a risk of significant losses

The loss can also be multiplied, just like amplified returns. The leveraged ETF may lose as much as 3 points if the index falls by 1 point.

Let's now look at the pros and cons associated with a leveraged ETF.

What to Consider Before Investing in a Leveraged ETF

To ensure that you make an informed decision before you invest in leveraged ETFs, you should consider the following:

1. Consider how much of your portfolio you would like to invest in a leveraged ETF. Here, consider your risk tolerance.

2. You can find out what the total cost is - administration fee, management fee and the expense ratio.

3. Know which sectors and indexes you are most familiar with. If you are an expert in information technology, investing in a leveraged ETF which tracks an IT index is a smarter choice.

4. Check the past performance of any fund you are interested in investing. Fair warning: Past performance does not predict future performance. It is best to be indicative.

5. Learn about the investment objectives of the leveraged ETF you are interested in. To get a better understanding of the fund's objectives, you can consult its prospectus.