Leveraged and Inverse ETFs
ETFs are typically registered investment companies whose shares represent an interest in a portfolio of securities that track an underlying benchmark or index. (Some ETFs that invest in commodities, currencies or commodity- or currency-based instruments are not registered as investment companies.) Unlike traditional mutual funds, shares of ETFs typically trade throughout the day on a securities exchange at prices established by the market.
A leveraged ETF is an exchange-traded fund (ETF) that utilizes financial derivatives and debt to amplify the returns of an underlying index. The fund essentially borrows money and combines this money with investors' money to purchase derivatives such as options, futures, or swaps. Because of the use of debt and derivatives, these ETFs carry a significant amount of risk. These funds also generally charge higher expenses to shareholders, which results in reduced returns (or increased losses if the market goes against the investment objective of the fund).
Leveraged and inverse ETFs typically are designed to achieve their stated performance objectives on a daily basis. Leveraged inverse ETFs (also known as “ultra short” funds) seek to achieve a return that is a multiple of the inverse performance of the underlying index. An inverse ETF that tracks a particular index, for example, seeks to deliver the inverse of the performance of that index, while a 2x (two times) leveraged inverse ETF seeks to deliver double the opposite of that index's performance.
Most leveraged and inverse ETFs “reset” daily, meaning that they are designed to achieve their stated objectives on a daily basis. Their performance over longer periods of time can differ significantly from the performance or inverse of the performance of their underlying index or benchmark during the same period of time. This effect can be magnified in volatile markets.