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| Shorting and Leverage |
Essentials of Leveraged &
Inverse Investing PDF |
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If you have a strong belief that the market is headed upward, you may want to invest in a leveraged mutual fund or ETF, which strives to multiply the return of an index. In addition, with leveraged investment products you have the opportunity to employ less capital to gain the same exposure—freeing up assets for other investments.
This increased exposure to an index is achieved through the use of instruments such as derivatives (e.g., futures, swaps and options) as well as the underlying securities that enable the leveraged investment to pursue its objective.
Leverage applied consistently at 200% on 10 consecutive days
with 2% changes in the underlying hypothetical stock index*
The example above demonstrates that consistently applied leverage, when coupled with compounding, may increase an investor’s long-term prospect for outperformance versus the underlying index. The possibility of outperforming the underlying index can increase dramatically with the length of the holding period. Of course, investors need to understand that leverage works both ways and that there is a risk of negatively compounded performance as well.
It’s important to note that the use of leverage by a mutual fund or ETF increases the risk to the fund. The more an investment product invests in leveraged instruments, the more the leverage will magnify both gains and losses on those investments.
Using Leveraged Investment Products
For investors seeking to outperform an index, leveraged index funds and/or ETFs may be an option as part of a well-diversified portfolio.
| Potential Advantages
of Leveraged Funds |
Potential Disadvantages
of Leveraged Funds |
• Added market exposure without increased investment costs
• Control market exposure based on your needs
• Take advantage of short-term
tactical or long-term stategic
opportunities
• No margin paperwork or margin calls
• Gain overlay exposure to a
specific market |
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• Increased volatility—the more a mutual fund or ETF invests in leveraged instruments, the more the leverage will magnify any gains or losses on those investments
• The value of the funds’ futures and options contracts and other securities may fluctuate significantly from day to day—which may cause the value of the funds to decrease and experience higher losses |
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* This example is hypothetical and for illustration purposes only. Please note: A common misconception is that the total return of an inverse fund will generate the exact opposite of the total return of the index to which it is benchmarked. This will not be the case for any time period beyond one day. Due to the nature of compounding, it would be virtually impossible to produce a total return that is exactly opposite the total return of the index over any time frame beyond one day.
This piece is intended to be for information purposes only. Investors should discuss these concepts and their personal financial situation with their financial advisor or advisors prior to making any investment decisions.
Inverse funds and leveraged funds may not be suitable for all investors. Investing in short/inverse funds involves certain risks, which may include increased volatility due to the funds' possible use of short sales of securities and derivatives such as options and futures. The funds are subject to active trading risks that may increase volatility and impact the funds' ability to achieve their investment objectives. The use of leverage by a mutual fund increases the risk to the fund. The more a mutual fund invests in leveraged instruments, the more the leverage will magnify any gains or losses on those investments.
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