QID----Leveraged ETFs Double Returns, But Also Risk

Leveraged ETFs Double Returns, But Also Risk
Tuesday April 3, 7:00 pm ET
Trang HoLeveraged long and short funds are gaining popularity with sophisticated investors.

They can increase returns if you're right, but carry extra risk.

Theyoffer up to double the returns of a long or short position in an index,without having to double the amount of money at risk. Though hardly anovel concept, ProShares is the first and only to offer them as ETFs.

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(In 2000, Rydex launched the Dynamic S&P 500 (NASDAQ:RYTTX - News) mutual fund, which offers 200% of the daily returns of the benchmark.)

ProSharesreleased the bulk of its 46 Ultra and UltraShort funds in February. Butthe company started developing the funds in 1999.

Only theSecurities and Exchange Commission can answer why it took the fundsseven years to reach the market, says ProShares CEO Michael Sapir.

Margin

"Theseare strategies that have been used by large investors for a long time.A lot of investors didn't use these strategies because they wereinaccessible or prohibited," Sapir said. "In a pension account, youcan't margin, therefore you generally can't leverage your investment orgo short."

Twelve of the ProShare funds double the long andinverse returns of six Russell indexes. Twenty-two double the long andshort returns of 11 Dow Jones sector indexes. The rest track broaderindexes such as the Dow, Nasdaq 100 and S&P 500.

UltraShort QQQ (AMEX:QID - News)aims to go up 10% if the Nasdaq 100 goes down by 5% in one day. Butdon't expect UltraShort QQQ to be ahead exactly 100% if the Nasdaq 100loses 50% over a year or any given period.

Compounding

Why?Because of the mathematical effects of daily compounding andrebalancing. Say an index falls by 3% two days in a row. A 3% drop thefirst day would then set a lower baseline for the second day. If theindex declined 3% from there, the result would be a decrease of 5.91%for the index, but an 11.64% increase for the UltraShort fund at theend of day two.

Leveraged funds have an obvious advantage in amarket that's in a definite uptrend or downtrend. It's much easier tobuy a short fund than it is to short an individual stock or index.

Theoretically, there's no limit on how much you can lose when selling short because a stock's price can rise infinitely.

A long position, however, can never fall below zero. Likewise with an ETF, you can only lose the amount you invested in an ETF.

The potential to double returns also comes with double the risk, warns Sapir of ProShares.

"Iwouldn't recommend that anyone take all their retirement and put it inan Ultra fund," Sapir said. "They are additional tools that manyinvestors may find useful in an overall portfolio."