Leveraged ETFs were in the headlines a great deal in 2009, but most of the coverage was less than favorable. Misinformation on these products was widespread throughout the year, leading to confusion on many aspects of these products and some unfair generalizations.
One of the primary points of discussion was the performance of leveraged ETFs when held by investors for extended periods of times. Because these funds focus on delivering amplified returns on a daily basis, returns over time are compounded, meaning that the effective return over multiple sessions depends not only on the change in the underlying benchmark, but in the path of the index during that period. In trending markets, the return to leveraged ETFs will generally be greater than the simple target multiple times the return on the underlying index. But in seesawing markets — one where gains are frequently followed by losses and vice versa — the compounding of returns can cause erosion of returns to investors who buy and hold.
In 2008, markets experienced unprecedented volatility. While leveraged ETFs were efficient in accomplishing their stated objectives (i.e., leveraged daily returns), the constant oscillation in markets produced negative annual returns for many leveraged funds. This year has been a different story, as the VIX has retreated from all time highs to its long-term average and the frequency of triple digit swings in the Dow has decreased significantly.
Some investors mistakenly believe that leveraged ETFs held for more than a single day are guaranteed to lose money. Below is a look at ten ETFs that have clearly debunked this myth in 2009 by delivering impressive returns (for more reviews of the best-performing ETFs, sign up for our free ETF newsletter):
10. ProShares Ultra Consumer Services (UCC)
Designed to deliver daily returns equal to 200% of the daily return on the Dow Jones U.S. Consumer Services Index, UCC has gained about 60.7% to far this year. The iShares Dow Jones U.S. Consumer Services Sector Index Fund (IYC), an unleveraged ETF linked to the same index, has added about 30% in 2009, meaning that UCC’s return is almost exactly twice that of IYC for the year.
9. ProShares Ultra MidCap 400 (MVV)
Mid cap stocks have been among the best performers of 2009 so far, so it follows that a few leveraged mid cap ETFs would make this list. With the objecctive of delivering daily returns equal to 200% of the daily return on the S&P MidCap 400, MVV has added about 63% in 2009. The iShares S&P MidCap 400 Index Fund (IJH) is up about 34% for the year.
8. ProShares Ultra Russell 1000 Growth (UKF)
Not far behind mid caps are large cap equities, and the fund offering 200% daily leveraged exposure to the Russell 1000 Growth Index has gained almost 67% on the year. The iShares Russell 1000 Growth Index Fund (IWF) is up about 33%, just less than half of UKF’s return.
7. ProShares Ultra Russell MidCap Growth (UKW)
Another leveraged mid cap ETF, UKW is designed to deliver daily returns equal to 200% of those on the Russell MidCap Growth Index. This ETF has jumped 86% in 2009, while the iShares Russell MidCap Growth Index Fund (IWO) is up 43%.
6. ProShares Ultra QQQ (QLD)
The PowerShares QQQ Trust (QQQQ) boasts one of the most recognized ticker symbols, and the fund offering 200% daily leverage on the NASDAQ-100 Index is one of the year’s biggest gainers. QLD has gained about 107% in 2009, while QQQQ is up a very impressive 49% year-to-date.
5. ProShares Ultra Semiconductor (USD)
After a disastrous 2008, the semiconductor industry staged an impressive recovery in 2009, as sales of gadgets picked up and hopes of an imminent tech refresh cycle increased. These factors have pushed USD up 114% on the year. Unleveraged semiconductor ETFs, including SMH, IGW, XSD, and PSI, are up between 40% and 87% so far in 2009.
4. ProShares Ultra Basic Materials (UYM)
Increases in manufacturing activity this year have resurrected demand for basic materials in 2009, and this sector has been one of the top performers. This ETF is designed to deliver daily results equal to 200% of the Dow Jones U.S. Basic Materials Index, and has added about 114%. The iShares Dow Jones U.S. Basic Materials Index Fund (IYM) has gained 58% this year, about half the return on UYM.
3. ProShares Ultra Technology (ROM)
The technology sector has been one of the stars of 2009, and this leveraged technology plays has posted some of the strongest gains on the year. ROM, which seeks to deliver daily returns equal to twice those of the Dow Jones U.S. Technology Index, is up about 130%. The iShares Dow Jones U.S. Technology Index Fund (IYW) has added about 57% this year, well below half the gains on ROM. The Also delivering impressive results this year has been the Rydex/SGI 2x S&P Select Sector Technology ETF (RTG), which has gained about 104% in 2009.
2. Direxion Emerging Markets Bull 3x Shares (EDC)
Emerging markets have emerged as the leaders of the global recovery that is now underway in most parts of the world, returning to growth (significant growth in many cases) long before developed economies. So it should be no surprise that a 3x leveraged emerging market ETF is near the top of this list. EDC seeks daily returns equal to 300% of the performance of the MSCI Emerging Markets Index, and has added 133% in 2009. The Vanguard Emerging Markets ETF (VWO) is up about 70% in 2009.
1. Direxion Technology Bull 3x Shares (TYH)
Another technology ETF heads the list of the top performing leveraged ETFs of 2009, this time a 3x bull fund from Direxion. TYH seeks daily investment results equal to 300% of daily returns on the Russell 1000 Technology Index, and has gained more than 160% this year.
Proceed With Caution
The impressive performances turned in by these ETFs in 2009 shows that holding leveraged ETFs over multiple sessions isn’t necessarily portfolio suicide. But it should be noted that all of these leveraged ETFs focus on daily returns, and are very vulnerable to “return erosion” in volatile markets. If we experience another year like 2008, leveraged ETFs will perform in much the same way they did then.
For more reading on leveraged ETF performance over time, see Understanding Returns Of Leveraged and Inverse Funds, a comprehensive study prepared by Joanne Hill and George Foster of ProShares.
Disclosure: No positions at time of writing.