| NEW YORK, Sept 5
NEW YORK, Sept 5 Leveraged exchange-traded
funds, designed to magnify short-term returns, have fallen out
of favor this year as investors who had embraced them are
finding costs excessive in a calm market that is not rewarding
bets on wild daily swings.
The funds may continue to lack appeal as markets show no
indication that fear will enter into the trading equation
anytime soon, with equities shrugging off all manner of negative
Broad-market volume is down this year, with the most widely
traded ETF, the SPDR S&P fund, posting a 13.8 percent
drop in August from a year ago. Leveraged funds are getting hit
even harder, with declines of 25 to 30 percent.
Leveraged ETFs aim to offer daily returns at a multiple to
an underlying index. But the funds carry high expense ratios and
trading costs, making them less appealing because small daily
moves are not enough to justify the expense.
Market volatility has been non-existent of late. The CBOE
Volatility Index lately traded at 12.73, after having
fallen in July to its lowest level since February 2007, at
"In such a low-volatility environment, the institutional
firms that use leveraged funds to hedge may not feel they're
worth the cost," said Joel Dickson, senior ETF strategist at
Vanguard in Valley Forge, Pennsylvania.
The funds are designed to be one-day holdings, and
purchasing and selling a fund in the same session results in
twice the commissions and fees that a trader has to pay compared
with a buy-and-hold investor. Those costs, along with the low
volatility, "further eat up whatever profits might result,"
The ProShares Ultra S&P 500 fund, which offers
double the daily return of the S&P 500, has both a gross expense
ratio and a net expense ratio of 0.9 percent, far greater than
the SPDR S&P 500 fund, which has a GRE of 0.1 percent and a NER
of 0.0945 percent.
Another fund, the Direxion Small Cap Bull 3X Shares,
has a gross expense ratio of 1.07 percent and a net expense
ratio of 0.95 percent.
"The fees are really high by ETF standards, and they're not
as cost effective as they would be if we were getting big market
moves," said Michael Rawson, fund analyst at Morningstar in
"In proportion to the returns you could potentially get
they're not so bad, but if you're speculating on the market you
could go out and just buy high-momentum stocks."
In addition to the expense ratios, leveraged funds negotiate
a total-return swap with major banks in order to get the
necessary exposure to deliver the promised multiple.
The cost of these swaps are not "always disclosed, but
they're generally not cheap," said Dave Nadig, chief investment
officer at ETF.com in San Francisco, who estimated the costs at
50 basis points to 2.5 percent "depending on what's being
swapped. That comes out of your total return."
LOW VOLATILITY, LOW VOLUME
The VIX is well below its long-term average of 20, and
overall market moves have been slim of late. Over the past 250
sessions the S&P's average daily move, either up or down, has
been 14.29 points, or about 0.7 percent. That's an average that
has been rarely hit recently.
Total August trading volume for the ProShares S&P fund fell
34 percent from August 2013, though shares are up 17.4 percent
on the year. Volume fell 26 percent at the ProShares UltraShort
S&P 500 ETF, which corresponds to twice the inverse
daily move of the S&P, and 33 percent for the Direxion small-cap
fund, which attempts to offer three times the daily move of the
"Not only is volatility exceptionally low, but general
interest levels have been declining," said Stephen Sachs, head
of capital markets at ProShares in Bethesda, Maryland.
Alternative ETF providers like ProShares are not trading
outfits, so they have not been directly affected by the drops in
trading action. They make money from management fees that are
tied to a fund's assets under management and are "within normal
ebbs and flows" in the current environment, Sachs said.
Other fund providers, including Direxion and VelocityShares,
also said they were not experiencing significant declines in
revenue from the current environment, and are not planning any
changes to their business - such as launching or closing funds.
(Editing by Leslie Adler)