• Short FTSE/Xinhua China 25 (YXI): This ETF would seek to deliver daily investment results equal to the inverse of the daily change in the FTSE/Xinhua China 25 Index. This index consists of 25 mega-cap Chinese equities, and is the basis for the largest U.S.-listed China ETF (FXI). ProShares already offers 200% and -200% ETFs based on the FTSE/Xinhua China 25 Index (XPP and FXP, respectively).

• Ultra Nasdaq Biotechnology: This ETF would seek daily investment returns equal to 200% of the daily return on the Nasdaq Biotechnology Index, a benchmark tracked by the iShares Nasdaq Biotechnology Index Fund (IBB).

• UltraShort Nasdaq Biotechnology: This ETF would be linked to the same index, seeking to deliver daily returns equal to -200% of the daily change in the index.

• Short Basic Materials (SBM): This ETF would seek to deliver daily returns equal to the inverse of the Dow Jones U.S. Basic Materials Index, a benchmark covered by the iShares Dow Jones U.S. Basic Materials Index Fund (IYM). ProShares currently offers 200% and -200% leveraged ETFs (UYM and SMN, respectively).

• Short Real Estate (REK): This proposed ETF would be designed to deliver daily returns equal to the inverse of the daily return on the Dow Jones U.S. Real Estate Index. ProShares Ultra Real Estate (URE) and UltraShort Real Estate (SRS) both offer leveraged exposure to this index, and the iShares Dow Jones U.S. Real Estate Index Fund (IYR) offers simple 1x exposure.

Leveraged ETF Boom

Already this year, ProShares and Direxion have launched several new products, many of which have seen heavy initial trading volumes. In January, ProShares launched a pair of 200% leveraged Treasury ETFs. The company launched eight more ETFs last month, including funds offering 300% and -300% daily exposure to the Nasdaq 100, Dow Jones Industrial Average, S&P MidCap 400, and Russell 2000.

Direxion has also expanded its product lineup significantly this year, launching the first ETFs offering leveraged exposure to short-term Treasuries in February. Earlier this week, trading began on six new leveraged ETFs from Direxion, including the company’s first 2x and -2x funds. In total, nearly 20 new leveraged ETFs have hit the market already this year.

Disclosure: No positions at time of writing.

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Each of the new products is an industry first of some sort. Both ProShares and Direxion offer leveraged products linked to the MSCI Emerging Markets Index, but BRIL and BRIS are the first leveraged ETFs offering exposure to the BRIC economies. INDL and INDZ are the first leveraged ETFs linked to Indian markets, joining funds from both major leveraged ETF issuers based on China indexes. SOXL and SOXS are the first 3x leveraged ETFs focusing on a semiconductor-specific benchmark. There are a number of “plain vanilla” semiconductor ETFs, including SMH, IGW, XSD, and PSI. These 1x semiconductor ETFs have aggregate assets of nearly $1.7 billion and average trading volumes of more than 15 million shares. ProShares already offers both 200% daily leveraged (USD) and -200% daily leveraged ETFs (SSG) linked to the Dow Jones U.S. Semiconductors Index.

“Direxion strives to provide innovative investment solutions that enable investors to employ tactical portfolio strategies amid changing market conditions,” stated Dan O’Neill, Direxion Shares’ President. “We have provided the investment community with many industry ‘firsts.’ With this launch, we are pleased to offer the first 2x leveraged BRIC and India ETFs. The BRIC economies represent some of the fastest-growing in the world, and we are pleased to provide a vehicle for trading in these markets.”

The BRIC and India funds are the first leveraged ETFs offering 2x exposure from Direxion. Historically, the company has dominated the 3x leveraged ETF space while ProShares has focused on inverse and 2x leveraged funds. In recent months ProShares has expanded into the 3x leveraged ETF space, and now Direxion has ventured into offering 2x leverage. Through the first two months of 2010, cash inflows into leveraged ETF products exceeded $1 billion, indicating that these funds remain tremendously popular among a variety of investors.

BRIL and BRIS are linked to the BNY Mellon BRIC Select ADR Index, a benchmark tracked by Claymore’s BRIC ETF (EEB). INDL and INDZ are based on the Indus India Index, which is tracked by the PowerShares India Portfolio (PIN).

Disclosure: No positions at time of writing.

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• Top Ten Performing Leveraged ETFs Of 2009

• Ultra MSCI Brazil: Seeks daily returns equal to 200% of the daily returns on the MSCI Brazil Index.
• Ultra Pacific ex-Japan: Seeks daily returns equal to 200% of the daily returns on the MSCI Pacific ex-Japan Index.
• Ultra MSCI Europe: Seeks daily returns equal to 200% of the daily returns on the MSCI Europe Index.
• Ultra MSCI Mexico Investable Market: Seeks daily returns equal to 200% of the daily returns on the MSCI Mexico Investable Market Index.

In June 2009, ProShares launched UltraShort products that seek to deliver 200% of the inverse of daily returns of the same four indexes. iShares currently offers ETFs designed to replicate the performance of three of these benchmarks, including EWZ (Brazil), EPP (Pacific ex-Japan), and EWW (Mexico). The Vanguard European ETF (VGK) is linked to the MSCI Europe Index.

Leveraged / Inverse Regional Banking ETF

In addition to the four 200% long international ETFs, ProShares has three funds based on the KBW Regional Banking Index in the works:

• Ultra KBW Regional Banking (200% daily exposure)
• Short KBW Regional Banking (-100% daily exposure)
• UltraShort KBW Regional Banking (-200% daily exposure)

The KBW Regional Banking Index is an equal-weighted benchmark consisting of companies that do business as regional banks or thrifts. State Street’s KRE, which is designed to track the performance of this index, has been one of the best-performing ETFs to date in 2010, gaining more than 10% on the year. This impressive performance comes after this sub-industry missed out on last year’s rally: KRE was one of the worst-performing equity ETFs last year.

Already this year more than 20 banks have been closed, and FDIC officials said that the pace of bank seizures is likely to accelerate in coming months. The number of banks on the “problem” list increased to 702 in the fourth quarter from just 552 three months earlier (read more on regional bank ETF options in this feature).

If approved and launched, thees funds would join existing ETFs offering leveraged exposure to the broad financial sector. ProShares’ lineup includes ETFs providing 200% (UYG), -200% (SKF), and -100% (SEF) daily exposure to the Dow Jones U.S. Financials Index. Direxion’s Daily Financial Bull 3x Shares (FAS) and Bear 3x Shares (FAZ), which are based on the Russell 1000 Financial Services Index, are two of the most widely-traded ETFs, with average daily volumes of about 30 million shares and 61 million shares, respectively.

Expense ratios for all of the new ETFs are pegged at 0.95%, consistent with existing ProShares products.

Disclosure: No positions at time of writing.

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The addition of TWOL and TWOZ expands Direxion’s leveraged fixed income offerings to six funds, joining 300% and -300% ETFs linked to the the NYSE Arca Current 10-Year U.S. Treasury Index (TYD and TYO) and NYSE Arca Current 30-Year U.S. Treasury Index (TMF and TMV). While most leveraged ETFs are linked to equity benchmarks, leveraged bond funds have seen a surge in popularity over the last year. According to the latest industry figures from the National Stock Exchange, leveraged bond ETF assets exceed $5 billion, with the vast majority of that amount in inverse funds. The ProShares UltraShort 20+ Year Treasury (TBT) took in more than $2 billion alone last year.

While ProShares and Direxion both offer leveraged products focusing on long-term and intermediate-term fixed income benchmarks, TWOL and TWOZ will be the first to cover short-term Treasuries. In the current environment, the new funds should attract significant interest from investors looking to play changing interest rates. “The yield on the 2-Year Treasury is historically highly correlated to the Federal funds rate, which many sophisticated investors are currently anticipating movement in due to changing inflation expectations,” stated Dan O’Neill, Direxion Shares’ President. “As a provider of sophisticated investment solutions designed to help optimize institutional-style portfolio strategies, we think it’s an apt time to introduce the only ETFs that offer leveraged exposure to the 2-Year Treasury on both the long and short side, as investors prepare for the Federal Reserve to act.”

Interest Rates In Focus

The outlook for interest rates has become complicated in recent weeks, following some surprising data releases and comments from the Federal Reserve Chairman to Congress. Last week, the U.S. Labor Deportment reported that core CPI–which excludes volatile food and energy prices–fell last month for the first time in nearly 30 years (see Five ETFs For The Great Deflation). Following the massive stimulus plans implemented to revive the U.S. economy, many investors had been expecting an uptick in inflation to force the Fed’s hand in moving rates higher. So the unexpected decline was perhaps an indication that keeping rates near record lows may be sustainable for longer than had been anticipated.

In testimony before the House Financial Services Committee this week, Fed Chairman Ben Bernanke repeatedly stressed that rates need to remain low to ensure that the recovery will last and unemployment will begin to fall. Not surprisingly, Bernanke’s words sent markets in motion: November fed funds futures contracts now have priced in about a 66% chance of a 50 basis point rate hike after the meeting on November 2nd and 3rd. At the start of the week, the same contracts were reflecting nearly a 95% likelihood.

For news on all new ETF product launches, sign up for our free ETF newsletter.

Disclosure: No positions at time of writing.

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The new fund launches bring the number of 3x leveraged ProShares ETFs to ten. The company launched the UltraPro S&P 500 (UPRO) and UltraProShort S&P 500 (SPXU) in June 2009, and through January these funds had accumulated almost $270 million in aggregate assets.

By expanding its product line to include more 300% leveraged ETFs, ProShares will begin competing more directly with Direxion, the ETF issuer that pioneered 300% leverage and has historically dominated the space. ProShares’ Russell 2000 ETFs will compete directly with Direxion’s Daily Small Cap Bull 3x Shares (TNA) and Daily Small Cap Bear 3x Shares (TZA). Direxion’s product line consists of 26 leveraged ETFs based on 13 indexes, including broad-based and sector-specific equity benchmarks,  developed and emerging markets, real estate, and fixed income.

ProShares has also registered fixed income, developed markets, and emerging markets ETFs offering 300% leverage.

For updates on all new ETF launches, sign up for our free ETF newsletter.

Disclosure: No positions at time of writing.

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Historically, ProShares has focused on inverse, 200% leveraged and 200% inverse leveraged ETFs, although the issuer expanded its offerings outside this area last year when in introduced the first 130/30 ETF. Several of the proposed funds, which are based on domestic and international equities and fixed income ETFs, would compete directly with existing products from Direxion.

Direxion’s 3x leveraged and inverse leverage Russell 2000 ETFs (TNA and TZA, respectively) had almost $600 million in aggregate assets at the end of January, while the company’s 3x and -3x emerging markets ETFs (EDC and EDZ, respectively) had more than $500 million in assets. ProShares also filed prospectuses for 300% funds based on the MSCI EAFE Index, a benchmark covered by Direxion’s DZK and DPK.

Despite facing a firestorm of criticism last year and the implementation of regulatory changes in December of 2009, leveraged ETFs have continued to surge in popularity. According to data from the National Stock Exchange, leveraged and inverse leveraged ETFs saw almost $10 billion in net cash inflows last year.

Disclosure: No positions at time of writing.

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ProShares has offered the UltraShort 7-10 Year Treasury (PST) and UltraShort 20+ Year Treasury (TBT) since April 2008. TBT in particular has seen its popularity surge as investors bet against long-dated Treasuries: the fund saw cash inflows of $2.2 billion in 2009 and is now the largest leveraged ETF by total assets.

The new ProShares products could compete with existing 3x leveraged funds from Direxion. The Daily 10 Year Treasury Bull Shares (TYD) seeks to deliver daily returns equal to 300% of the change in the NYSE Arca Current 10-Year Treasury Index, while the Daily 30-Year Treasury Bull Shares (TMF) is linked to the 30-Year U.S. Treasury Index. Direxion also offers a pair of inverse leveraged ETFs linked to Treasury benchmarks: the Daily 30 Year Treasury Bear Shares (TMV) and Daily 10 Year Treasury Bear Shares (TYO).

Trading Opportunities

U.S. Treasuries have historically been identified as offering risk-free returns, but that notion has been turned on its head in recent years. Treasuries surged towards the end of 2008 as investors flocked to safe haven investments. Between August 2008 and Christmas of that year, the iShares Barclays 20+ Year Treasury Bond Index Fund (TLT) gained almost 35%. The fund then lost more than 20% of its value in 2009. But perhaps even more astonishing than these significant swings in value of Treasuries is the daily volatility Treasuries have exhibited. Since August 2008, TLT has gained or lost at least 1% in more than 35% of trading sessions. The fund has swung by at least 2% in nearly one in ten trading days. And this occurred during a period of time that saw interest rates hold steady near all time lows.

The unprecedented market conditions obviously contributed to the volatility of Treasuries over the last two years, but government bonds could continue to see big swings in value going forward. The moves of the Federal Reserve are watched more closely than ever before, and every hint of a leaning on interest rate policy can send equity markets either surging or plummeting. Interest rates can’t stay at near zero levels forever, and once the Fed resumes activity in this regard, trading activity could surge.

Treasuries figure to be in focus in coming months for another reason as well: inflation. While most economists agree that increases in CPI will see an uptick from current levels, opinions as to just how high inflation will go vary significantly. Some see rates settling in the Fed’s “comfort zone,” while others are preparing to profit from a period of hyperinflation that crosses into double digits. Since Treasuries are fixed income investments, the real value of coupon payments can be impacted significantly by the prevailing rate of inflation. As the recovery progresses, Fed meetings and releases of CPI data will become must see events for everyone on Wall Street.

To stay up to date on all new product launches this year–we’ve only seen the tip of the iceberg so far–sign up for our free ETF newsletter.

Disclosure: No positions at time of writing.

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• Direxion Launches Leveraged Short Term Treasury ETFs (TWOL, TWOZ)
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Because leveraged funds are designed to deliver amplified returns on a benchmark on a daily basis, their exposure is reset daily. Consequently, returns to these funds over multiple trading sessions depend on both the change in the underlying index and the path of the benchmark during the period in question. In trending markets, the return on a leveraged ETF often exceeds the simple product of the target multiple and change in the benchmark. In seesawing markets, the compounding effect can lead to results that are less than daily target multiple times the index movement. In certain environments, a leveraged bull fund may deliver negative returns over an extended period even if the underlying index advances.

Over the last month, the law firm of Stull, Stull & Brody has been churning out class action lawsuits against leveraged ETF issuers, alleging that wrongdoing in the promotion of these products. While the firm may make a splash and grab a few headlines, the lawsuits lack any substantive claims, and border on downright embarrassing to those behind them. The prospectuses for leveraged clearly spell out that the objectives of the funds are daily in scope. Beyond the official documents from the issuer, the quantity of publicly-available information covering these topics is astounding. It’s unfortunate that some investors failed to comprehend how leveraged ETFs work and incurred losses as a result, but the logic behind assigning the blame to the issuers of the funds seems flawed.

Beyond the basic premise of the lawsuits–that leveraged ETFs were sold as instruments that would deliver amplified results regardless of holding period–there are a number of curious accusations. The press release announcing an investigation into the ProShares Ultra Basic Materials (UYM) notes that the law firm is investigating claims that ProShares “failed to disclose in its registration statements: (i) that if shares of the Funds were held for a time period longer than one day, the likelihood of massive losses was huge; and (ii) the extent to which performance of the Funds would invariably diverge from the performance of the benchmark.”

It’s tough to tell what exactly is meant by “the likelihood of massive losses was huge,” but proving that notion to be false should be relatively simple. A number of studies have shown that leveraged ETFs, while not designed to do so, have historically done a pretty good job of delivering leveraged results over multiple sessions (one such study was recently published here).

Another interesting allegation comes from a press release announcing that the same firm was investigating the Direxion Energy Bear 3x Shares Fund (ERY). The firm notes that the Russell 1000 Energy Index fell approximately 11% between November 5, 2008 and April 9, 2009 while the 3x bear Direxion fund linked to this benchmark fell approximately 54% over the same period. Besides conveniently using the wrong name for the fund–it’s actually the Direxion Daily Energy Bear 3x Shares–and erroneously computing the return on the Russell Energy Index over the time period in question, the release notes that:

Given the spectacular tracking error between the performance of the ERY Fund and its benchmark index, investors in the ERY Fund have been shocked to learn that their supposedly correct play on the energy sector has caused them substantial losses. The fact that Plaintiff and the Class sought to protect their assets by investing their monies on the correct directional play has been rendered meaningless. The ERY Fund is, therefore, the equivalent of a defective product. The ERY Fund did not do what it was designed to do, represented to do, or advertised to do.

This accusation seems like a slam dunk to defend as well. It’s made pretty clear that ERY operates with a daily objective, seeking to deliver daily investment results corresponding to 300% of the inverse of the daily change in the Russell 1000 Energy Index. Over the time period in question (and since then), ERY did a very good job of accomplishing its stated objective. The fund delivered daily returns between -250% and -350% of the daily change in the Russell 1000 Energy Index more than 70% of the time. If the range is expanded to -200% to -400%, the success rate jumps above 85%. These clearly aren’t results typical of a “defective product.”

ETFdb Pro members can read more about the underpinnings of leveraged ETFs in the ETFdb Category Report (if you’re not a Pro member yet, sign up for a free trial or read more here).

What’s Next?

The ETF industry has gathered tremendous momentum over the last two years, attracting hundreds of billions of dollars from mutual funds and expanding the scope of product offerings to cover almost every corner of the investable universe. The wave of lawsuits will likely be little more than a speed bump along the way.

But it is a threat to the industry’s growth. Given the seemingly frivolous nature of the recent suits, it wouldn’t be surprising if other issuers and products are soon targeted. Why not take aim at commodity products? The United States Natural Gas Fund (UNG) may do exactly what its prospectus says it will, but many investors expect the fund to track movements in spot prices, and it doesn’t. Or how about the iShares Emerging Markets Index Fund (EEM)? The strategies used are clearly outlined in registration materials, but the fund trailed its benchmark by about 7% in 2009 due primarily to sampling strategies.

Of course, such suits would be without much merit. But that clearly hasn’t been much of a deterrent in the past.

Disclosure: No positions at time of writing.

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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.

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“In general, FINRA is increasing the maintenance margin requirements for leveraged ETFs and associated uncovered options by a factor commensurate with their leverage,” reads the notice. Prior to the change, the maintenance margin for any long ETF was 25% of its market value and the margin for any short ETF was 30% of its market value. Under the new rules, these margin requirements will increase by a percentage commensurate with the leverage of the ETF, not to exceed 100% of the value of the fund.

In the notice, FINRA notes that NASD Rule 2520(f)(8)(A) allows the organization, in response to market conditions, to prescribe higher initial and maintenance margin requirements. “In view of the increased volatility of leveraged ETFs compared to their non-leveraged counterparts, FINRA believes higher margin levels are necessary,” reads the notice.

Since FINRA announced its intentions to raise margin requirements nearly four months ago, the firestorm of controversy surrounding leveraged ETFs has subsided considerably. Much of the focus on these funds has centered on their performance when held for multiple trading sessions. Because they focus on delivering daily returns equal to an amplified daily result on an underlying index, leveraged ETFs can see “return erosion” in oscillating markets.

During the unprecedented volatility in late 2008 and early 2009, the compounding of daily returns led to big losses for both bull and bear leveraged funds. But as volatility has returned to a normal level, the frequency and severity of these occurrences has declined significantly, and many investors have seen compounding work for them in trending markets.

What It All Means

Beginning on December 1, margin requirements for leveraged ETFs will increase significantly, and will range from 50% for 2x long funds to as high as 90% for 3x inverse funds.

The impact of the changes will take some time to evaluate, but we wouldn’t be surprised if the impact on day-today trading is minimal. Ideally, the new regulations would help to ” trim down the field of investors and test for suitability,” wrote Don Dion when the announcement was initially made.

Earlier this year, several brokerages discontinued use of leveraged ETFs in client portfolios, citing the disconnect between long-term strategies and the short-term focus of the funds. Many thought this would lead to a significant decline in use of leveraged ETFs, but trading volumes didn’t drop at all, leading us to believe that the vast majority of ETF investors are sophisticated individuals and institutions who understand the nuances of leveraged funds and know exactly what they’re doing. ProShares and Direxion, the leaders in the leveraged ETF space, saw aggregate cash inflows of more than $2 billion to their funds in September and October, another indication that this corner of the ETF industry will continue to be embraced by risk-hungry investors.

We’re keeping a close eye on volumes this week and next as the changes take effect – be sure to check back for an update on how this situation plays out. For all the news on the ETF industry delivered to your inbox, sign up for our free ETF newsletter.

For more information on the upcoming regulatory changes, see the official FINRA document.

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