Leveraged ETFs And International ETFs
Background • Bull ETFs: 2x or 3x an index’s return • Bear ETFs: 1x, 2x or 3x the inverse of an index’s return • Use leverage and derivative contracts to replicate these returns • In the U.S.: • 13% of the ETF universe by # of funds • 26% of the ETF trading volume • In Canada: • 26% of the ETF universe • 61% of the ETF trading volume
Background • Confusion in the marketplace • Class action law suits • SEC, FINRA, and IIROC investor alerts • Morgan Stanley, UBS and BoA have banned their financial advisors from recommending them to clients • Example of the confusion • 2008 performance TSX Global gold index: 0.8% HGD (2x bear ETF): -84.5%!
Factors influencing returns: Compounding • Designed to replicate daily returns. • What happens if you hold the fund for two days? Net return of the index is: Net return of the 2x bull ETF is: Net return of the 2x bear ETF is:
Factors influencing returns: Compounding • Same implication for longer holding periods • In general, • Momentum (or trends) works in the investor’s favour • Negatively autocorrelated returns will result in a loss even if index breaks even
Factors influencing returns: Management • Previous example assumed perfect replication. There may be addition deviations due to the different risks involved • Use of leverage • Use of derivatives, e.g., index swaps, futures, forwards • Replication and trading typically outsourced to structured product and derivative specialists
Factors influencing returns: NAV vs. Market prices • Another layer that affect’s investors’ bottom line • ETF could be trading at a premium or discount • Discount: NAV per share > market price • Premium: NAV per share < market price • Additionally, when liquidity is reduced (e.g., during the financial crisis), bid-ask spreads go up
International ETFs • Consider ewj • Managed by BlackRockiShares • Index: MSCI Japan (345 stocks) • MER: 0.56% • Because of the time difference, when it is traded in New York, the Japanese market is closed • Question: what do the price movements of ewjreflect?
International ETFs • Potential strategies? • Consider the following: • Short sell ewj, ewh, ewk and fxi at noon on September 15, 2008 • Close out the positions within the first 15 minutes of regular trading on the 16th • Would have earned: 3.49% on ewh, 8.38% on ewy, 7.83% on fxi , and 1.22% on ewj, all in less than 24 hours
Additional Information • The market for ETFs • Ownernship (Institutional/Retail): U.S. (50/50), Europe (90/10)