New ETFs Seek a Boost With Leverage

It seems like every month the Securities and Exchange Commission approves more and more new exchange-traded funds. In fact, at least 10 firms have a total of 291 ETFs waiting for SEC approval.

ProShares launched 22 funds on Feb. 1. Each of the funds tracks a Dow Jones index covering a narrowly focused industry group. Eleven of the new funds take the positive or long side, rising as the index rises. The other 11 take the short side, rising as the indices fall. The funds use leverage in an attempt to return twice the performance of the indices.

It is true that these new ETFs intentionally lack diversification by being industry-specific. But the 200% leverage does allow an investor to balance a portfolio with half as much cash equity.

For traders, the leverage amplifies small movements and the ability to bet an industry will fall, both without the use of a margin account.

It will be a year before TheStreet.com Ratings' risk-adjusted return model has enough performance and volatility data to generate a rating for these new ETFs. However, it is not too soon to see how the underlying indices did in the last year, which could give an indication about how the ETFs would have performed.

The table below lists the Dow Jones indices tracked by ProShares' new ETFs and the total return for each. The comparable performance level shows how each index would have stacked up against the one-year returns of funds we rate.

The Most Diversified ETFs
Dow Jones Index Name	1 Year Total Return	Comparable Performance Level to Funds We Rate
U.S. Real Estate	35.40%	Top 30%
U.S. Utilities	19.00%	Middle 40%
U.S. Financials	18.80%	Middle 40%
U.S. Consumer Services	16.90%	Middle 40%
U.S. Consumer Goods	15.50%	Middle 40%
U.S. Industrials	14.10%	Middle 40%
U.S. Technology	9.40%	Bottom 30%
U.S. Health Care	8.80%	Bottom 30%
U.S. Oil & Gas	7.80%	Bottom 30%
U.S. Semiconductors	-6.60%	Bottom 30%
Source: Bloomberg on 2/6/2007

When doubling the returns, we can see what the hypothetical return might have been assuming no expenses and no tracking errors. The UltraShort funds were multiplied by -200% to show their double inverse relationship to the underlying indices.

The hypothetical performance level approximates how the funds might have ranked on a one-year total return basis against the funds we currently rate. Leverage can work in your favor if you pick the correct direction of the index. As of Feb. 6, the one-year total return of 16.9% on the Consumer Services index could have turned into an excellent return of 33.9%.

On the other hand, leverage can do significant damage to your portfolio if you make a mistake on which way the market is moving. With the exception of the fund levered to the semiconductor index, which fell for the year, all of the UltraShort funds would have been caught on the wrong side of a bull market for these sectors, knocking the stuffing out of your portfolio.

Fund & Ticker	Hypothetical ETF Leverage +/- 200%	Hypothetical Performance Level
Ultra Real Estate ProShares (URE)	70.70%	Top 30%
Ultra Utilities ProShares (UPW)	37.90%	Top 30%
Ultra Financials ProShares (UYG)	37.70%	Top 30%
Ultra Consumer Services ProShares (UCC)	33.90%	Top 30%
Ultra Consumer Goods ProShares (UGE)	31.10%	Top 30%
Ultra Basic Materials ProShares (UYM)	29.00%	Top 30%
Ultra Industrials ProShares (UXI)	28.20%	Top 30%
Ultra Technology ProShares (ROM)	18.80%	Middle 40%
Ultra Health Care ProShares (RXL)	17.50%	Middle 40%
Ultra Oil & Gas ProShares (DIG)	15.70%	Middle 40%
UltraShort Semiconductors ProShares (SSG)	13.20%	Middle 40%
Ultra Semiconductor ProShares (USD)	-13.20%	Bottom 30%
UltraShort Oil & Gas ProShares (DUG)	-15.70%	Bottom 30%
UltraShort Health Care ProShares (RXD)	-17.50%	Bottom 30%
UltraShort Technology ProShares (REW)	-18.80%	Bottom 30%
UltraShort Industrials ProShares (SIJ)	-28.20%	Bottom 30%
UltraShort Basic Materials ProShares (SMN)	-29.00%	Bottom 30%
UltraShort Consumer Goods ProShares (SZK)	-31.10%	Bottom 30%
UltraShort Consumer Services ProShares (SCC)	-33.90%	Bottom 30%
UltraShort Financials ProShares (SKF)	-37.70%	Bottom 30%
UltraShort Utilities ProShares (SDP)	-37.90%	Bottom 30%
UltraShort Real Estate ProShares (SRS)	-70.70%	Bottom 30%

This analysis does not consider volatility, the risk portion of our ratings. Only the hypothetical performance is listed and compared with the average total returns of the top 30%, middle 40% and bottom 30% groups of the funds we rate. So the above table does not represent how these funds could have done on an overall risk-adjusted return investment rating.

The 200% leverage employed by these funds increases volatility, resulting in worse risk ratings when ranked against nonleveraged funds holding the same stocks. Caution is warranted.