One small corner of the ETF universe could help you triple your gains this year.
Leveraged and inverse ETFs are just 2 percent of the ETF market, but when used properly, they can supercharge a portfolio’s performance.
Sylvia Jablonski, managing director of capital markets at Direxion, said that for the experienced investor with a strong market viewpoint and expectations of low volatility, those products can be used to generate high alpha.
“They are daily rebalanced products, so they’re meant to be at least actively monitored on a daily basis and short-term trading periods,” said Jablonski on CNBC’s “ETF Edge ” on Wednesday.
Leveraged ETFs deliver multiples on the performance of an index. For example, the SPXL S&P 500 bull 3x ETF would amplify any move by 300 percent, so a one-day 5 percent increase would translate to a 15 percent gain. An inverse ETF, such as the SPXS S&P 500 bear 3x ETF, would generate returns on any declines in the index by three times the move.
These kinds of investment products are not for the faint of heart, though.
“Here’s where they trick you,” said Jablonski. “For two days, if you had a 5 percent move upward, you’re up 32.25 percent (so 15 percent plus 15 percent, plus the effect of daily rebalancing). … The trend is your friend; compounding rebalance works in your favor.”
For example, over the 10 years to 2018, the TECL technology bull 3x ETF generated a return of 5752 percent, compared to a 480 percent return on the IXT technology ETF. In that case, the upward trend and considerably low volatility in the group helped the compounding rebalance work for that ETF.
High volatility, however, degrades any returns generated by leveraged ETFs.
“If you’re up 5 [percent], down 5, you’re not zero as you would be in Apple, IBM, etc.,” said Jablonski. “You’re down 2.25 because of that same compounding balance.”
Volatility in the gold miners worked against both bulls and bears in the space, she explained. Both the NUGT gold miners bull 3x ETF and the DUST gold miners bear 3x ETF have generated negative returns since 2011.
For the tactical and actively managing investor, a leveraged position could work in a portfolio, said Jablonski. The trick is to know when to use them.
“A great example is around earnings. So Boeing crushed earnings; you had AMD come out and crush earnings, ” she said. “If you have a conviction that the direction of the semiconductor index will be upward and volatility will be low for the next couple of days, you might put on a 3x position, keep an eye on it, and when you generate some alpha in the short term, offload your position.”
She added: “So much of it is your view on markets and volatility.”