Article: Leveraged/Short ETFs

An interesting article from Note, when the mainstream press finally writes an article about something like this, it can be viewed as a contrary indicator, especially when it comes after a rapid decline that was accompanied by extreme sentiment readings and “the sky is falling” cover stories on most/all major newspapers and magazines. If that were the case, we would expect the January 23rd intra-day low to be the low of the first leg of the bear market. The next leg down beginning when that low is breached on a closing basis and then experiences a failed retest. Speaking of retests, it wouldn’t be surprising to see the recent low retested soon. Now on to the article:

January 31, 2008
Leveraged/Short ETFs Offer Big Rewards — and Risks

EACH WEEK, LIPPER, the fund data provider, generates a list of the previous week’s 25 top- and bottom-performing exchange-traded funds for us. Without fail, the same company, ProShares, makes the list. The firm not only boasts funds that hover near the top of the rankings, but also claims some that dwell down in the basement, too.

There’s a simple explanation for ProShares’ consistently mixed showing: its leveraged and short ETFs. Conventional ETFs try to mirror the returns of a static index, say the Nasdaq 100, by owning the same stocks in that benchmark (in this case, the hundred biggest Nasdaq-listed firms). However, 50 ProShares funds — the company calls them “ultra” ETFs — take that idea a step further by using a series of derivatives to obtain double the returns of a given bogey, regardless of whether it’s increasing or decreasing in value. For example, the ProShares UltraShort QQQ (QID: 47.90, -1.07, -2.18%), the ETF that tracks the inverse returns of the Nasdaq 100, is up 32.2% this year, while the index is down 13.3% through yesterday. Only a sinigle ETF that focuses on semiconductors turned in a better performance.

Returns like that, especially when the broad market has tanked 5% in the last month, is a primary reason why investors have started taking a serious look at leveraged and short ETFs — a group that typically resides on the fringes of the industry. Their ability to post outsize returns regardless of market conditions is a powerful calling card. After just two years, ProShares has attracted $10 billion in assets to its family of 58 ETFs. Rydex, its rival and neighbor in the suburbs of Washington, D.C., recently launched a competing lineup. No doubt others will follow suit as hedge funds, institutions and even do-it-yourselfers pour more money into these funds.

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