Glossary
Leveraged ETF
An ETF that aims for a multiple, such as 2x or 3x, of an index's daily return; compounding makes long-run results diverge.
A leveraged ETF is a fund that tries to return a fixed multiple of an index's performance, such as 2x or 3x, for one day. If the index gains 1% today, a 3x fund aims to gain about 3%. The fund gets the extra exposure with swaps and futures rather than a margin loan, so the holder cannot lose more than the amount invested. The daily target, however, means the fund's return over weeks or years can be very different from the multiple of the index's return.
How daily resetting changes the result
Each day the fund rebalances so that its exposure is again exactly the target multiple of its assets. After a gain it buys more exposure; after a loss it sells. Over time this compounds in a way that hurts in choppy markets.
In a strong, steady trend the same compounding can produce more than the multiple, so long-run outcomes depend heavily on volatility and on the order of returns.
What to watch for
FINRA has warned since 2009 that leveraged and inverse funds are usually built for very short holding periods and may not suit long-term investors. Expense ratios are typically around 1% a year, plus the cost of financing the swaps. A severe one-day drop in the index can erase most of a 3x fund's value. Under the LULD plan, leveraged ETPs are Tier 2 securities with wider price bands.