Leveraged ETFs fall out of fashion, as market waves subside

Major leveraged funds have seen massive drops in assets and volume in a low-volatility environment

The U.S. stock market has been so quiet of late that the opportunity to increase one's daily return by a factor of two or three--or even four, now--is one that investors have been increasingly able to pass up.

Leveraged exchange-traded funds have seen massive outflows over the past year, along with lower trading volume, as the market's persistently low volatility means that their high costs and greater risk isn't coming with a commensurate boost in gains. Some of the most popular funds have shed more than a quarter of their assets over the past 12 months.

The category of ETF, which is highly speculative and designed to be a short-term holding, delivers a multiple of an underlying index's one-day gain through the use of derivatives and futures contracts. So on a day when the S&P 500 rises 1%, for example, the ProShares Ultra S&P 500 ETF (SSO) should return 2%, while both the ProShares UltraPro S&P 500 ETF (UPRO) and the Direxion Daily S&P 500 Bull 3X Shares (SPXL) will climb 3%. Conversely, declines also are amplified.

On Tuesday, the Securities and Exchange Commission approved the market's first quadruple-leveraged ETF, as well as its inverse equivalent, though they haven't yet begun to trade. The fund is designed to deliver 400% of the daily move of the S&P 500, while the inverse delivers -400% (inverse funds rise when the underlying index falls), meaning the hypothetical 1% move would turn into 4%.

The issue is, 1% daily moves in either direction have been in short supply of late. Thus far in 2017, there have only been three such sessions, an abnormally low number. It has been more than 160 days since the S&P 500 fell 1.5%; the average interval is 22 days, according to Salil Mehta, a statistician and a former director of analytics for the Treasury Department's TARP program.

Over the past five sessions, not including Wednesday, the biggest move by the S&P 500 came when it closed down by less than 0.2%. Michael Harris, a trader who now runs the Price Action Lab Blog, dubbed recent market action the "most boring six days in 23 years."

"The change from highest high to lowest low of this 6-day tight range is only 0.7144%," he wrote, calling that value " very low." The lowest such value, using data that goes back to 1965, occurred in 1994, and was 0.7094%.

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In this environment, even the multiplied returns offered by leveraged ETFs look tepid, particularly when viewed against their higher trading risks. The category tends to have wider spreads and a larger tracking error than traditional funds, both of which can eat into potential profit, and the fees can be many times larger.

The ProShares Ultra S&P 500 ETF has an expense ratio of 0.89%, while the Direxion Daily S&P 500 Bull 3x Shares (SPXL) charges 1.06%. A nonleveraged S&P ETF, such as the SPDR S&P 500 ETF Trust (SPY) , offers a ratio of 0.09%.

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Perhaps given the recent performance and fees, investors have been withdrawing from leveraged funds. The 2x ProShares fund has seen outflows of $56.9 million in so far in 2017, and of $102 million over the past 12 months. Both triple- leveraged funds have seen outflows of more than $120 million, which accounts for a sizable portion of ProShares' triple- leveraged fund, which has under $900 million in assets.

Other funds have seen even more dramatic outflows. The ProShares UltraPro QQQ (TQQQ), which looks for triple-leveraged exposure to the Nasdaq-100 , has had outflows of $540 million over the past 12 months, reducing its assets by more than a quarter, to $1.46 billion.

Trading volumes have also dropped precipitously. The twice-leveraged S&P 500 fund had trading volume of 45.4 million shares over all of April, down more than 37% from April 2016. The triple-leveraged ProShares had monthly volume drop 39% year-over-year.

-Ryan Vlastelica; 415-439-6400; AskNewswires@dowjones.com


  (END) Dow Jones Newswires
  05-05-17 1312ET
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