DIY InvestorMagazine
/
March2014
DIY InvestorMagazine
/
March2014
28
29
MASTERCLASS - EIGHTTHINGS TOKNOWABOUT
SHORT& LEVERAGEETFS/ETPS
Exchange Traded Product (ETP) is an umbrella term
which encompasses Exchange Traded Funds (ETFs),
Exchange TradedNotes (ETNs) and Exchange Traded
Commodities (ETCs).
ETPs can provide exposure to all asset classes
including equities, commodities, fixed income,
currencies and alternatives. ETPs have existed since
2005 and leverage for many centuries; today there are
almost $61bn of assets in leveraged and short ETPs
which are traded onmost of themajor global stock
exchanges.
Due to the combined features of leverage and daily
compounded returns, these types of ETPs are trading
instruments which need to be clearly understood
before an investor should invest. However, once
understood they can be highly efficient tools,
providingmagnified long and short exposure in an
efficient product wrapper.
Boost ETP (
), is one of only a few
specialist providers of short and leveraged (SL) ETPs to
the Europeanmarket with a focus on delivering added
value by issuing highly innovative products.
The company has education, transparency and
thought leadership at its core and herein considers
eight key things that it believes investors need to
know about short and leveraged ETPs, using its own
products as examples.
1. LEVERAGEDRETURNS
Leveraged returns magnify the daily returns of an
unleveraged investment. For example, the charts
below show that if the FTSE 100 rises by 1% in a day,
the Boost FTSE 100 3x Leverage Daily ETP (3UKL) will
rise by 3% (excluding fees and adjustments).
Conversely, if the FTSE 100 falls by 1%, the Boost
FTSE 100 3x Short Daily ETP (3UKS) will rise by 3%.
Leverage returns allow an investor to either use less of
their capital to achieve a similar investment (2/3 less
in the case of 3x leverage) or tomagnify returns using
the same amount of capital.
Index
Boost3x LeveragedDaily ETP
BOOST3X LEVERAGEDDAILYETP
1%
3%
-
1%
-
3%
UPDAY FORTHE INDEX
DOWNDAY FORTHE INDEX
BOOST3XSHORTDAILYETP
Index
Boost3x ShortDaily ETP
1%
3%
-
1%
-
3%
UPDAY FORTHE INDEX
DOWNDAY FORTHE INDEX
2.WHAT INDICESDO SL ETPS TRACK?
Boost SL ETPs track a range of liquid, blue-chip indices;
they either track a specially designed 3x daily leveraged
or 3x daily short index (such as the ShortDAX X3 TR
EUR Index) that calculates the leveraged return inside
the index, or they track an unleveraged index (such as
the NASDAQ Commodity Crude Oil ER Index) and for
which the 3x or -3x daily leverage is applied in the same
way that the short or leverage index is constructed.
3. HOW IS THE SHORTAND LEVERAGE
POSITIONACHIEVED?
An investor buying £100 of a 3x Leverage Daily ETP
receives £300 of exposure consisting of £100 cash
and £200 of borrowed funds (charged at the interbank
lending rate) to achieve an investment of £300.
The borrowing cost is deducted from the daily return
and is either incorporated into the index or the
calculation of the ETP price.
An investor buying £100 of a 3x Short Daily ETP
effectively borrows £300 of the index which is sold
short; £400 (£100 from the investor and £300 from the
short sale of the index) is then invested at inter-bank
cash rates.
The cost of the stock-borrow and interest income on the
cash is incorporated into the calculation of the ETP price
each day.
4. DAILYRE-BALANCING
Boost Short and leverage Daily ETPs rebalance their
leverage at the end of every index trading day, providing
investors with a 3x or -3x daily returns. This is slightly
different to usingmargin or buying or selling a futures
contract to obtain leverage.
Daily ‘constant leverage’ is used because an open-ended
ETP allows for investors to buy and sell the ETP on
any day and still receive the stated leveragemultiple.
Leverage based on a ‘constant dollar’ amount is not
possible as the amount of leverage experienced by each
investor depends on the amount and day the investment
was made.
Monthly leverage (or some other frequency of re-
balancing) could be used but then the actual leverage an
investor was exposed towould depend onwhat day of
themonth they bought the investment. Daily leverage
simplifies this issue.
5. COMPOUNDING - ITS EFFECTS
As with any investment, returns over periods longer
than one day are affected by compounding due to
market movements (like a bank account may compound
interest over manymonths).
Daily leveraged exposuremeans the compounding
effect will be amplified and occur daily, which can have
a positive or negative effect on returns over longer
periods.
If the FTSE 100 price is £100 and rises by 1%, the Boost
FTSE 100 3x Leverage Daily ETP (3UKL) will rise by 3%
to £103 (excluding fees & adjustments). If the FTSE 100
then falls by 1% the next day, then 3UKL will fall to
£99.91.
Thus over the two days the average return is 0%,
however the 2-day compounded ETP return is -0.09%.
The Index would also have an average return of 0% but
its price would be £99.99 and its 2-day compounded
returnwould be -0.01%.
The daily compounding effect may increase with the
length of a holding period, index volatility and leverage.
These charts show the effects of compounding on
returns. In the ‘VolatileMarket’ chart the indexmoves
6. INTRA-DAYCRASH PROTECTION
Boost ETPs are designed to prevent the ETP from
falling to $0 in one day. If amarket move is extreme,
e.g the FTSE 100 falls by 20% (60% including
leverage) then 3UKL rebalances intra-day to ensure
that the ETP does not go to $0.
The intra-day rebalancing reduces the sensitivity
of further falls below 20%whilemaintaining some
exposure to a rebound.
Similarly, if the FTSE 100 rises by 20%, then 3UKS
would rebalance intra-day.
ADVERTISING FEATUREBYBOOSTETP
(Source: Boost ETP LLP)
VOLATILEMARKET
1.8%
4.1%
-7.7%
-10%
-8%
-6%
-4%
-2%
0%
2%
4%
6%
8%
0 1 2 3 4 5 6 7 8 9 10 11
DAY
CUMULATIVERETURN
Index
3x LeverageDaily
3x ShortDaily
2%
2%
2%
-
2%
-
2%
-
2%
-
2%
-
2%
2%
-3%
-2%
-1%
0%
1%
2%
3%
0
2%
1
2%
3
5
7
9
11
DAY
DAILYRETURNOF INDEX
DAILYRETURNOF INDEX
CUMULATIVERETURN
Index
3x LeverageDaily
3x ShortDaily
TRENDINGMARKET
24.3%
89.8%
49.4%
-60%
-40%
-20%
0%
20%
40%
60%
80%
100%
0 1 2 3 4 5 6 7 8 9 10 11
DAY
2% 2% 2% 2% 2% 2% 2% 2% 2% 2% 2%
0%
1%
1%
2%
2%
3%
0 1 2 3 4 5 6 7 8 9 10 11
DAY
(Source: Boost ETP LLP)
up and down by 2% per day. After 11 days, the Index
is up by 1.8%, the Boost 3x Leverage Daily ETP would
be up only 4.1% (2.3x the Index) and the Boost 3x
Short Daily ETP is down 7.7% (-4.3x the Index).
The ‘TrendingMarket’ chart shows the outcome over
11 days, where the index increased by 2% each day.
After 11 days, the Index is up by 24.3%, the Boost
3x Leverage Daily ETP would be up only 89.8% (3.7x
the Index) and the Boost 3x Short Daily ETP is down
49.4% (-2.0x the Index).
However, on a day to day basis, the Boost 3x Leverage
Daily ETP and Boost 3x Short Daily ETP has done
exactly as it is supposed to do.
