By Gary Gordon of ETF ExpertLegitimate criticism of leveraged ETFs is rapidly fading from the blogosphere. In fact, a number of my peers serve up "champagne-and-caviar-like" praise for leveraged ETFs. There may be a reason for that and that reason may be a direct or indirect advertising/financial arrangement. In fact, one wonders why there isn't a warning label with, "Caution: Commentators receive compensation from Leveraged ETF provider." There's nothing inherently evil about relationships such as these. It happens in every sector of private or public business. That said, investors should genuinely understand "behind-the-scene" dynamics. For instance, let's assume that a leveraged ETF provider wanted to compensate me through an advertising relationship at my Web site(s). Naturally, I would fulfill my obligation to disclose the relationship. What's more, investors would hear how leveraged ETFs offer sophisticated traders short-term opportunities. I'd even insist upon explaining pitfalls that occur in leveraged ETF use. Nevertheless, should I accept a relationship with a leveraged ETF provider, it would clearly become a question of emphasis. What wouldn't I be emphasizing to readers? Would investors realllllllllllly recognize just how problematic buying-n-holding a leveraged ETF can be? Here is a concrete example for the public domain: ProShares UltraShort Real Estate ( SRS). This ETF seeks daily investment results, before fees and expenses, corresponding to 2x (200%) the inverse (opposite) of the daily performance of the Dow Jones U.S. Real Estate Index. Credit the ProFunds ProShares Web site for emphasizing that SRS pursues -200% of the return of the index for a single day. Still, let's not get carried away by the appropriate disclosure. As each day goes by, you are less and less likely to achieve the inverse relationship that you believed might be possible. This is primarily due to the way compounding works; that is, it is not mathematically probable for daily tracking to resemble weekly, monthly or annual percentage gains or losses that might be implied.
Suppose you were shrewd enough to recognize the trouble with real estate investment trusts at the very start of 2008. So you set a course for "Ultrashorting." With the iShares DJ Real Estate Fund ( IYR) losing about -40%. Wow, you might expect to be up about 80%! Sorry, Chuck. ProShares UltraShort Real Estate didn't gain 2x the annual inverse. It didn't gain 1x the annual inverse. In fact, it didn't even gain; rather, SRS lost -50%!!! Congratulations are still in order, though. The folks at ProFunds ProShares would be quick to remind you that you did indeed achieve 2x the inverse of the daily performance of the Dow Jones U.S. Real Estate Index. Unfortunately, instead of raking in 80% gains, you lost -50% on your annual performance review. Half your capital ... ouch! If you'd like to learn more about ETF investing... then tune into "In the Money With Gary Gordon." You can listen to the show "LIVE", via podcast or on your iPod.