Leveraged ETFs are best suited to heightened, but not extreme, market unpredictability and are intended to be held for a few hours or days.GETTY IMAGES
Retail investors are increasingly turning to Canadian leveraged exchange-traded funds to weather – and even benefit from – the market volatility of on-again, off-again U.S. tariffs and threats.
Leveraged ETFs have become the fastest-growing ETF category in the country as investors appear to be hungry for big returns and willing to accept the corresponding higher risks.
In June, Canadian leveraged and inverse ETFs received $432-million in inflows, the highest percentage growth among all ETF asset classes in the country, according to a report by National Bank Financial.
Leveraged ETFs use the power and complexity of derivatives, including total return swaps, futures and options to amplify performance. The funds can magnify gains or losses by two or three times compared with actual market returns. Inverse ETFs bet that a particular market or asset will fall.
These specialized funds are inherently tactical and they are intended to be owned for only a few hours or days, at maximum, to take advantage of short-lived market conditions such as interest-rate announcements, economic data, or bellwether earnings reports, says Steve Hawkins, CEO of LongPoint ETFs.
Heightened market volatility is one of the key drivers behind the popularity of leveraged funds, but they are best suited to moderate – not extreme – unpredictability, says Raghav Mehta, vice-president and ETF strategist with Global X Investments Canada Inc., which offers more than 32 leveraged ETFs through its BetaPro series.
“When the markets are clearly trending up, or clearly trending down smoothly, that’s when the [leveraged] ETFs compound favourably over a couple of days,” Mr. Mehta says. “We don’t want to be owning these products when markets are super choppy and super volatile.”
Owners of leveraged ETFs do not buy and hold, he adds. “I like to call them ‘traders’ more than ‘investors.’ They are like speculators.”
Toronto-based LongPoint and BetaPro lead the leveraged ETF category in Canada and they are beefing up their exposures in hopes of satisfying Canadian investors who previously sought out U.S. leveraged funds because of limited selection at home. According to LongPoint, there are 196 leveraged and inverse-leveraged exchange-traded products listed in the United States that track equity and fixed income indices, including 75 triple-leveraged (or higher) index funds. By contrast, Canada has a small fraction of that number, though it is growing.
“The big thing we are trying to do is repatriate Canadian investors to using Canadian ETFs versus going south of the border to use U.S. ETFs,” Mr. Hawkins says.
Home-grown leveraged ETFs sidestep the tax, currency and administrative headaches for Canadian investors who used to seek out U.S. counterparts.
Interest in higher-risk products is increasing. An Angus Reid Forum survey conducted for BetaPro late last year found that 27 per cent of more than 1,000 respondents said they would consider taking more investment risks, with 12 per cent interested in leveraged ETFs. The younger the investor, the higher the appetite for risk.
“We are now seeing a lot of people using these products and that is why issuers like us and others in the marketplace want to respond to this demand by launching more of these products,” Mr. Mehta says.
These vehicles are predominately utilized by active investors who are looking for sophisticated investment strategies with reduced risk, Mr. Hawkins says. He described them as a “one-ticket solution without having margin accounts, without having to deal with futures, without having to do all the inner workings to have your own leveraged exposure.”
The investor’s potential loss “is limited to your initially invested principal,” Mr. Hawkins adds. “You can’t lose more, whereas with a future you can potentially lose more than what margin you put up.”
That built-in sophistication and the daily adjustments come with sharply higher fees. Most leveraged ETFs charge 1.55 per cent of net asset value, compared with management-expense ratios for typical ETFs starting at 0.03 per cent and rising to 1 per cent for actively managed funds.
But Mr. Hawkins points out that the heftier fee for leveraged funds works out to pennies when the products are held short term as intended, potentially worth the price for what would otherwise be a complex investment for a do-it-yourselfer.