Last Updated: 21 November 2023
Matt, I had to reread your latest blog on www.indexuniverse.com and had to check the date, to see if this wasn’t April 1 all over again.
Is it really true that the Direxion Financial Bear 3x ETF (NYSE: FAZ) attracted the second-greatest inflow of any US-listed ETF in the year to date, US$4.6 billion, only to end May with just US$1.6 billion in assets? Even though the fund was relatively small in size at the beginning of 2009 – US$87 million, according to NSX data – that’s still over US$3 billion of investors’ money that has vanished into the ether.
And is it really true that, since its launch in November 2008, FAZ has lost 94% of its value, and that, from the mid-November peak end-of-day price of US$165.48 per share, it’s down 98%?
Just for the record, the three-times bullish ETF derivative of the same index, FAS, is down 78.6% over the same period since its November launch. And it was also valued at end-May at less than the cumulative cash flows so far this year (the fund’s assets were US$ 1.645 billion, net cash flows in the year to date US$1.65 billion). But that’s the joy of leveraged ETFs for you – or, as Direxion’s website puts it, “tactical tools for sophisticated, active investors”.
There may be investors who were lucky enough to benefit from the initial 10-day run-up in the price of FAZ after its debut but, for the rest of the time, investing in this three-times leveraged inverse financial sector fund, in fact in either FAS or FAZ, has been less like an exercise in sophistication and more akin to playing Russian roulette with five bullets in the revolver chamber.
I know we’ve covered the risks of leveraged and inverse funds at length on Index Universe, pointing out that for holding periods longer than a day they are guaranteed to diverge in performance from a simple multiple of the underlying index, but I remain perplexed at why so many investors wish to gamble with them. Maybe everyone involved believes they are good at market timing, even though the NSX data suggests that the only people really benefiting from these funds are the issuer and those who gain from the huge trading volumes they generate. I know I’m useless at tactical trading, having learned from hard experience, and so I wouldn’t touch these funds with a bargepole.
In Europe, where leveraged and inverse funds are much smaller as a proportion of the overall market – roughly 2% of the total assets under management, compared to 5% in the US – my latest copy of Deutsche Bank’s Liquidity Trends report tells me that they still accounted for a much larger 31% of overall ETF trading volume last week. I know that this measure is for on-exchange trading only, and that the larger, institutional trading volumes that occur over-the-counter are likely to be in more traditional funds. Even so, this tells me that European retail investors are enamoured of leverage as well, albeit on a much smaller scale than in the US.
Isn’t it ironic that, in a market which is still working off the effects of a massive credit bubble and excess economy-wide leverage, investors are playing on a very large scale with the gearing that got everyone into trouble in the first place? More than this, aren’t these funds at risk of bringing the whole ETF industry into disrepute?
I’ve always disagreed with John Bogle’s long-standing criticism of ETFs, believing that they compare well in terms of trading liquidity and flexibility with the index funds that he pioneered, and that his argument that ETFs encourage gambling was overdone. But, looking at the painful fallout from investors’ love affair with leveraged ETFs, wasn’t he right?