8709 in need of a boost itemid 127

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In Need Of A Boost

Written by Paul Amery

  
December 04, 2012 11:31 (CET)

The name chosen by Hector McNeil and Nik Bienkowski, ex-founders of ETF Securities, for their new venture—Boost—is exactly the opposite of what investors will experience if they buy and hold the triple leveraged and triple short exchange-traded products that Boost is about to start selling.

Boost announced today that it will list up to 100 triple daily leveraged and triple daily short ETPs on a range of asset classes over the next two years.

Boost’s ETPs will have to be listed securities, not funds, since Europe’s UCITS rules don’t allow funds to have leverage in excess of 200%. Boost is going for three-times gearing for its new ETPs, long and short, subject to the daily rebalancing that almost all leveraged and inverse trackers undergo. The firm says it will provide collateral backing for its ETPs in the form of sovereign bonds and equities.

As investors in non-fund ETPs do not benefit automatically from the regulatory safeguards built into Europe’s UCITS regime (such as automatic diversification of assets, an independent custodian and mandatory reporting requirements), potential investors in Boost’s new ETPs should check the prospectus carefully for any structural risks.

The key problem for any potential investor in a triple leveraged or triple short ETP is that the long-term expected return of the product is zero. If you buy one of these “trackers” and hold it, you are exposing yourself to the loss of all your money over time.

Leveraged ETPs are not the only type of exchange-traded product to fall into what I’ve called the “black hole club”. Commodity ETPs and volatility products suffering from contango will also eventually lose you most of your money. Look up a chart of VXX, remember the concept of radioactive decay if you did physics at school and you’ll get the idea.

If the issuers of these types of product take extra care to remind investors that holding them for just one night puts you over the edge and onto the beginning of that slippery slope, then I suppose they are at least describing them accurately.

Maybe they should also point out that investors or traders who believe they can forecast day-to-day market moves are guaranteed to fail too. But there’s no law against speculation and perhaps that’s a lesson we all need to learn for ourselves—the hard way.

Issuers of leveraged ETPs defend themselves against the accusation that they are exploiting naive investors who don’t understand the concept of exponential decay by arguing, as Boost does in its press release, that these trackers are “suitable for experienced and professional investors”.

But experienced and professional investors presumably also know how to use margin and short sell themselves, rather than exposing themselves to the unnecessary rebalancing costs that are inherent in leveraged ETPs. This raises the question of just whom these products are designed to serve.

I’ve heard enough supposedly sophisticated financial advisers standing up at conferences in the past and asking, for example, “China’s stock market went down 50% last year, so why did my triple short China tracker fall 70%?” to suggest that a lot of people don’t have a clue what they’re doing with this type of financial instrument.

In my opinion Boost’s co-CEO, Hector McNeil, is also skating on thin ice by making the following assertion in the company’s press release:

“Given the persistence of low, long term returns and sideways trending financial markets over the past five or more years, BOOST’s 3x leveraged ETPs should now give sophisticated investors valuable new tools to potentially enhance their investment returns or hedge market risks,” McNeil argues.

Mentioning sideways-trending markets and leveraged ETPs in the same sentence to me implies that you should consider holding the ETPs for longer than a day—precisely what you shouldn’t do.

Let’s hope the risk warnings that Boost will have to publishes in its ETPs’ prospectuses and the “significant educational support” it says it will offer investors “to ensure they can maximise their understanding and usage of the products” will make it clearer just how quickly things can go wrong.

Meanwhile, investors should remember that if they buy and hold these new ETPs their bank balances will very soon be in need of a boost too.

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