Thanks to heightened volatility and uncertainty, the leveraged and inverse leveraged space has grabbed investors’ attention at the start of October. This is because investors grabbed products in this space to magnify returns on quick market turns.
While the dual tailwinds of strong corporate earnings and a booming economy will likely keep the positive momentum alive in the stock market, soaring U.S. yields have taken a toll on investors’ appetite for U.S. equities, which have been outperforming international equities this year.
Additionally, the steep sell-off in Chinese equities has made investors jittery. The People’s Bank of China’s efforts to spur economic growth by cutting the reserve requirement ratios by 100 basis points effective Oct 15 failed to revive confidence in the world’s second-largest economy amid the escalating tariff dispute with the United States. The political turbulence in Italy added to the woes as the war of words between Rome and the European Union over the country’s budget escalated.
Further, the ongoing troubles in emerging markets especially in Argentina and Turkey, chances of auto tariffs on other countries, Iran oil sanctions, another budget deadline and the mid-term U.S. election in November are also weighing on global stocks.
All these have resulted in huge demand for leveraged or inverse leveraged ETFs as investors seek to register big gains in a short span. These products either create a leveraged long/short position, an inverse long/short position or a leveraged inverse long/short position in the underlying index through the use of swaps, options, future contracts and other financial instruments. Due to their compounding effect, investors can enjoy higher returns in a very short period of time provided the trend remains a friend.
However, these funds run the risk of huge losses compared to traditional funds in fluctuating or seesawing markets. Further, their performances could vary significantly from the actual performance of their underlying index over a longer period when compared to a shorter period (such as, weeks or months).
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