Understanding Leveraged ETF Bonds: A Guide for High-Net-Worth Investors

Leveraged ETF bonds are a type of investment that can offer high returns, but also high risks. They are not for the faint of heart, nor for the inexperienced investor. They are for those who have a high net worth, a high tolerance for volatility, and a keen understanding of the market dynamics.

In this article, we will demystify the concept of leveraged ETF bonds, explain how they work, and explore their benefits and drawbacks. We will also look at a real-world example of a leveraged ETF bond, and how it performed in different market conditions.

Finally, we will show you how you can use Kubera, a powerful wealth management platform, to track and analyze your leveraged ETF bond portfolio.

Introduction to Leveraged ETF Bonds: Demystifying the Concept

What are leveraged ETF bonds, and how do they differ from regular ETF bonds?

To answer this question, we need to first understand what ETFs and bonds are.

ETFs, or exchange traded funds, are securities that track an index, such as the S&P 500, and are traded on stock exchanges. They offer investors a convenient and cost-effective way to gain exposure to various sectors, asset classes, and strategies.

Bonds are debt instruments that represent a loan from an investor to a borrower, such as a government or a corporation. The borrower pays interest to the investor, and returns the principal amount at maturity. Bonds are considered fixed income securities, as they provide a steady stream of income to the investor.

ETF bonds are ETFs that invest in bonds. They allow investors to access the bond market without having to buy individual bonds. ETF bonds can track various types of bonds, such as corporate bonds, government bonds, municipal bonds, and more.

Leveraged ETF bonds are ETFs that use financial tools, such as derivatives and debt, to amplify the returns of an underlying bond index. The term ‘leveraged’ signifies the use of borrowed money to increase potential returns. For example, a 2x leveraged ETF bond aims to deliver twice the return of its underlying bond index on a daily basis.

Leveraged ETF bonds are not the same as regular ETF bonds. They have unique characteristics and risks that investors need to be aware of.

The Mechanics: Breaking Down How Leveraged ETFs Work & Their Unique Characteristics

Leveraged ETFs use financial derivatives, such as futures, options, swaps, and inverse ETFs, to create and maintain their leverage. Derivatives are contracts that derive their value from underlying assets, such as stocks, bonds, commodities, or currencies. Inverse ETFs are ETFs that aim to profit from stock declines, by moving in the opposite direction of their underlying index.

Leveraged ETFs also use debt, such as margin loans, to borrow money and invest in more derivatives. This increases their exposure to the underlying index, and thus their potential returns.

However, leverage is a double-edged sword. It can magnify both gains and losses, depending on the direction of the market. Leveraged ETFs are designed for short-term trading, not long-term investing. This is because of the effects of compounding. Compounding is the process of earning or paying interest on interest. It can have a significant impact on the performance of leveraged ETFs over longer periods of time. Compounding can lead to results that deviate from the expected performance of the underlying index.

For example, suppose a leveraged ETF bond tracks a bond index that returns 1% on a given day. The leveraged bond, with a 2x leverage factor, aims to return 2% on that day. However, if the bond index returns -1% on the next day, the leveraged ETF bond aims to return -2%. Over the two days, the bond index has a cumulative return of -0.01%, while the leveraged ETF bond has a cumulative return of -0.04%. The leveraged ETF bond has lost more than twice as much as the bond index, due to compounding.

Compounding can also work in favor of leveraged ETFs, if the market moves consistently in one direction. For example, if the bond index returns 1% for two consecutive days, the leveraged ETF bond will have a cumulative return of 4.04%, while the bond index will have a cumulative return of 2.01%. The leveraged ETF bond has gained more than twice as much as the bond index, due to compounding.

Another characteristic of leveraged ETFs is their volatility. Volatility is a measure of how much the price of an asset fluctuates over time. Leveraged ETFs are more volatile than regular ETFs, because they are more sensitive to market movements. A small change in the underlying index can result in a large change in the leveraged ETF. Volatility can be both a blessing and a curse for investors. On one hand, it can create opportunities for higher returns, if the market moves in the desired direction. On the other hand, it can also create risks for higher losses, if the market moves in the opposite direction.

Leveraged ETFs are not for everyone. They are for investors who have a high net worth, a high tolerance for risk, and a keen understanding of the market dynamics. They are for investors who are looking for short-term trading opportunities, not long-term investment strategies. They are for investors who are willing to monitor their positions closely, and adjust them accordingly.

Decoding the Language of Leveraged ETFs

Here are some of the terms and concepts that investors need to know when dealing with leveraged ETFs:

• Ticker: The ticker is a unique series of letters that represents a particular stock or ETF on an exchange. For example, TMF is the ticker for the Direxion Daily 20+ Year Treasury Bull 3X ETF, a leveraged ETF bond that we will discuss later in this article.
• Inception: Inception refers to the date when the ETF was first available for investment. For example, TMF’s inception date was April 16, 2009.
• NAV: The NAV, or net asset value, represents the value of an ETF’s total assets minus its total liabilities. It is calculated by dividing the total value of the ETF’s holdings by the number of shares outstanding. The NAV is usually updated at the end of each trading day, and may differ from the market price of the ETF.
• Issuer: The issuer is the institution that creates and manages the ETF. For example, TMF’s issuer is Direxion, a leading provider of leveraged and inverse ETFs.
• Disclaimer: The disclaimer is a statement that warns investors of the risks and limitations of the ETF. It is usually found in the ETF’s prospectus, a document that provides detailed information about the ETF’s objectives, strategies, costs, and ETF performance. For example, TMF’s disclaimer states: “An investment in the Fund involves risk, including the possible loss of principal. The Fund is non-diversified and includes risks associated with the Fund concentrating its investments in a particular industry, sector, or geographic region which can result in increased volatility. The use of derivatives such as futures contracts and swaps are subject to market risks that may cause their price to fluctuate over time. The Fund does not attempt to, and should not be expected to, provide returns which are a multiple of the return of the Index for periods other than a single day. For other risks, please read the prospectus.”

Direxion Daily 20+ Year Treasury Bull 3X (TMF) ETF: A Real-World Study

Now that we have a basic understanding of leveraged ETF bonds, let’s look at a real-world example: the Direxion Daily 20+ Year Treasury Bull 3X (TMF) ETF.

TMF is a leveraged ETF bond that trades on the NYSE. It aims to provide investors with three times the daily performance of the ICE U.S. Treasury 20+ Year Bond Index, before fees and expenses. The index tracks the performance of U.S. Treasury bonds with a remaining maturity of at least 20 years.

TMF has been around since its inception date of April 16, 2009. It is managed by its issuer, Direxion. As of December 18, 2023, TMF had a NAV of $23.76, and a market price of $23.77. It had 101.5 million shares outstanding, and a total net asset value of $2.4 billion. Its expense ratio was 0.95%, and its dividend yield was 0.64%.

Here is a snapshot of TMF’s recent performance:

The Direxion Daily 20+ Year Treasury Bull 3X (TMF) ETF has seen nearly $2.3 billion in inflows this year. Despite a 22% decline year-to-date, its assets have grown to $2.4 billion from $400 million a year ago.

But what makes TMF so appealing despite its volatility?

It’s a combination of its exposure to long-dated Treasuries and the current economic landscape.

TMF offers a unique proposition. It’s a leveraged ETF that provides triple exposure to long-dated Treasuries. This means that for every 1% movement in its underlying index, TMF aims to move by 3%.

Its high volatility makes it a favorite among short-term day traders. They are not in it for the long haul; they are looking to capitalize on short-term price movements.

However, with high reward comes high risk. TMF’s 22% year-to-date decline is a testament to that. But despite this decline, its assets have grown significantly, indicating continued investor interest.

Why are investors interested in long-dated Treasuries, and how does the economic landscape affect them?

Long-dated Treasuries are bonds issued by the U.S. government that have a maturity of 20 years or more. They are considered safe-haven assets, as they are backed by the full faith and credit of the U.S. government. They also offer higher yields than shorter-term Treasuries, as they compensate investors for taking on more duration risk.

Duration risk is the risk of losing money due to changes in interest rates. The longer the maturity of a bond, the higher its duration, and the more sensitive it is to interest rate fluctuations. When interest rates rise, bond prices fall, and vice versa.

The economic landscape in 2023 has been marked by uncertainty, inflation, and policy changes. These factors have affected the bond market in various ways.

• Uncertainty: The ongoing COVID-19 pandemic, geopolitical tensions, and environmental issues have created a lot of uncertainty in the global economy. This has increased the demand for safe-haven assets, such as long-dated Treasuries, as investors seek to preserve their capital and hedge against market volatility.
• Inflation: The unprecedented fiscal and monetary stimulus measures taken by governments and central banks to combat the economic fallout of the pandemic have fueled inflationary pressures. Inflation erodes the purchasing power of money and reduces the real return of fixed income securities. This has reduced the appeal of bonds, especially those with lower yields and longer maturities, as investors seek to protect their wealth from inflation.
• Policy changes: The Federal Reserve, the U.S. central bank, has been tapering its bond-buying program, known as quantitative easing, since November 2023. This program was intended to lower long-term interest rates and support the economic recovery. By reducing its bond purchases, the Fed is signaling its confidence in the economy and its intention to eventually raise its benchmark interest rate, which has been near zero since March 2020. This has increased the expectations of higher interest rates in the future, which has put downward pressure on bond prices, especially long-dated Treasuries.

These factors have created a complex and dynamic environment for leveraged ETF bonds, such as TMF. Depending on the market conditions, TMF can either benefit or suffer from its exposure to long-dated Treasuries. For example, if interest rates fall, TMF can generate higher returns than its underlying index, as bond prices rise. But if interest rates rise, TMF can incur higher losses than its underlying index, as bond prices fall.

Therefore, investors need to be aware of the market trends and the potential impact of economic events on leveraged ETF bonds. They also need to monitor their positions closely and adjust them accordingly, as leveraged ETFs are not suitable for long-term holding.

Here's a complete list of leveraged ETF bonds for those interested in exploring further:

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Unveiling the Science behind Leveraged ETFs: Research Perspectives

Is there any scientific evidence to support the use of leveraged ETFs in a portfolio?

According to a research paper published in 2018 by professors from the University of Massachusetts and the University of Connecticut, the answer is yes, under certain conditions.

The paper, titled “Leveraged ETFs, Holding Periods and Investment Shortfalls”, examined the effects of applying a leverage factor of 1.25x to a traditional 60/40 stock/bond portfolio. The researchers used historical data from 1926 to 2015, and simulated various holding periods, ranging from one day to 20 years.

The researchers concluded that some leverage, such as the 1.25x factor, can have long-term net return benefits to a 60/40 stock/bond portfolio under upward trending and lower volatility conditions. However, they also cautioned that higher leverage factors, such as 2x or 3x, can lead to significant investment shortfalls over longer holding periods, especially in downward trending and higher volatility conditions.

The paper also highlighted the importance of rebalancing the portfolio periodically, to maintain the desired leverage ratio and asset allocation. Rebalancing can help to reduce the risk of divergence between the leveraged ETF and its underlying index, and to capture the benefits of compounding.

The paper suggested that investors who use leveraged ETFs should consider the following factors:

• The leverage factor: The higher the leverage factor, the higher the potential return, but also the higher the potential risk. Investors should choose a leverage factor that matches their risk tolerance and investment objectives.
• The holding period: The longer the holding period, the more likely the leveraged ETF will deviate from its expected performance. Investors should use leveraged ETFs for short-term trading, not long-term investing.
• The market conditions: The direction and volatility of the market can affect the performance of leveraged ETFs. Investors should monitor the market trends and adjust their positions accordingly.
• The rebalancing frequency: The more frequently the portfolio is rebalanced, the more closely the leveraged ETF will track its underlying index. However, rebalancing also involves transaction costs and tax implications. Investors should balance the benefits and costs of rebalancing.

Understanding the Benefits and Risks of Leveraged ETFs in Different Market Conditions

Leveraged ETFs are not one-size-fits-all. Their performance can vary based on market conditions. Here are some examples of how leveraged ETFs can behave in different situations:

• Bull market: A bull market is a market where prices are rising or expected to rise. In a bull market, a bull leveraged ETF can provide higher returns than its underlying index, as it amplifies the positive movements. For example, if the index rises by 10%, a 2x bull leveraged ETF can rise by 20%. However, a bear leveraged ETF can incur higher losses than its underlying index, as it amplifies the negative movements. For example, if the index rises by 10%, a 2x bear leveraged ETF can fall by 20%.
• Bear market: A bear market is a market where prices are falling or expected to fall. In a bear market, a bear leveraged ETF can provide higher returns than its underlying index, as it amplifies the positive movements. For example, if the index falls by 10%, a 2x bear leveraged ETF can rise by 20%. However, a bull leveraged ETF can incur higher losses than its underlying index, as it amplifies the negative movements. For example, if the index falls by 10%, a 2x bull leveraged ETF can fall by 20%.
• Sideways market: A sideways market is a market where prices are moving within a narrow range, without a clear direction. In a sideways market, leveraged ETFs can suffer from erosion of value, as they are affected by the daily fluctuations of the market. For example, if the index moves up and down by 1% each day, a 2x leveraged ETF can lose 0.2% each day, due to compounding. Over time, this can result in a significant divergence between the leveraged ETF and its underlying index.

As you can see, leveraged ETFs can have different outcomes in different market conditions. Therefore, investors need to understand the benefits and risks of leveraged ETFs, and use them wisely and strategically.

The Case for Diversification: Leveraged ETFs in a Holistic Portfolio

Diversification is a cornerstone of investment strategy. It means spreading your money across different asset classes, sectors, and regions, to reduce your overall risk and increase your potential return. Diversification can help you achieve your financial goals, whether they are growth, income, or preservation of capital.

So, where do leveraged ETFs fit in a diversified portfolio?

Leveraged ETFs can be a part of a well-balanced portfolio, as long as they are used appropriately and proportionately. They can provide the potential for higher returns, but they also come with higher risk. Therefore, they should not be the main component of your portfolio, but rather a supplement to your core holdings.

Leveraged ETFs can help you diversify your portfolio in several ways:

• They can provide exposure to various sectors and asset classes, such as fixed income, commodities, currencies, and more. For example, you can use leveraged ETFs to gain exposure to the bond market, without having to buy individual bonds or regular ETF bonds.
• They can provide exposure to different market segments, such as large-cap, mid-cap, small-cap, value, growth, and more. For example, you can use leveraged ETFs to target specific segments of the stock market, such as the technology sector or the healthcare sector.
• They can provide exposure to different market strategies, such as momentum, volatility, inverse, and more. For example, you can use leveraged ETFs to profit from market trends, such as rising or falling prices, or to hedge against market risks, such as inflation or deflation.

However, leveraged ETFs also have some drawbacks that you need to be aware of:

• They can increase your portfolio volatility, as they are more sensitive to market movements. This can result in higher gains, but also higher losses, depending on the direction of the market.
• They can increase your portfolio costs, as they have higher expense ratios than regular ETFs. They also incur transaction costs and tax implications when you buy and sell them, or when they rebalance their holdings.
• They can increase your portfolio complexity, as they require more monitoring and adjustment than regular ETFs. You need to understand the leveraged ETFs you are investing in, and how they behave in different market conditions. You also need to review your portfolio periodically, and rebalance it to maintain your desired leverage ratio and asset allocation.

Therefore, you need to be careful and strategic when using leveraged ETFs in your portfolio. You need to consider your risk tolerance, investment objectives, time horizon, and market outlook. You need to choose the right leverage factor, holding period, and rebalancing frequency. You need to diversify your portfolio across different asset classes, sectors, and regions, and not rely solely on leveraged ETFs.

In-Depth Look at Leveraged ETFs – From Expense Ratios to Assets Under Management

Here are some of the key metrics and indicators that investors need to look at when evaluating leveraged ETFs:

• Expense ratio: The expense ratio is a measure of what it costs an investment company to operate an ETF. It is expressed as a percentage of the ETF’s net asset value, and it is deducted from the ETF’s returns. The expense ratio covers the ETF’s management fees, administrative fees, operating expenses, and other costs. For leveraged ETFs, the average expense ratio is 1.01%, according to ETF.com. This is higher than the average expense ratio of regular ETFs, which is 0.44%, according to Morningstar. This means that leveraged ETFs are more expensive to own than regular ETFs, and they can erode your returns over time.
• Assets under management (AUM): The AUM is the total market value of the assets that an ETF holds. It is calculated by multiplying the number of shares outstanding by the market price of the ETF. The AUM can indicate the size, popularity, and liquidity of an ETF. Generally, the larger the AUM, the more established and liquid the ETF is. However, the AUM can also fluctuate due to market movements, inflows and outflows, and share creation and redemption. Therefore, the AUM is not a static measure, and it should not be the sole criterion for choosing an ETF.
• Trading volume: The trading volume is the number of shares that are traded on an exchange during a given period of time, usually a day. The trading volume can indicate the liquidity, demand, and activity of an ETF. Generally, the higher the trading volume, the more liquid and accessible the ETF is. However, the trading volume can also vary due to market conditions, news events, and investor sentiment. Therefore, the trading volume is not a reliable measure, and it should not be the only factor for trading an ETF.
• Performance: The performance is the measure of how well an ETF has delivered on its investment objective. It is usually expressed as a percentage of the change in the ETF’s price or NAV over a given period of time, such as a day, a month, a year, or a longer term. The performance can indicate the return, risk, and efficiency of an ETF. Generally, the higher the performance, the more attractive the ETF is. However, the performance can also be misleading, as it does not account for the effects of compounding, volatility, fees, taxes, and other factors. Therefore, the performance is not a comprehensive measure, and it should not be the only basis for evaluating an ETF.

Navigating the World of Leveraged ETF Bonds with Kubera

How can you track and analyze your leveraged ETF bond portfolio with ease and efficiency?

The answer is Kubera, a powerful wealth management platform that is adept at handling the complexities of leveraged ETF bond portfolios and broader financial planning.

It offers a suite of features that cater to both seasoned and novice investors:

• Efficient Portfolio Management: Kubera's capabilities in automatically tracking bank and investment accounts, including leveraged ETF bonds, stand out. Its support for digital assets like crypto and DeFi assets across multiple chains, and the option to manually mark assets as investable or non-investable, provide a comprehensive view of your portfolio. This feature is particularly valuable for managing the high volatility and diverse nature of leveraged ETF bonds.
• Manual Marking: Kubera can allow you to manually mark your assets as investable or non-investable, depending on your preferences and goals. You can use this feature to customize your portfolio allocation, and optimize your investment strategy. For example, you can mark your leveraged ETF bonds as investable, and allocate a certain percentage of your portfolio to them. You can also mark your other assets, such as real estate, art, or collectibles, as non-investable, and exclude them from your portfolio calculation.
• Future-Forward Planning: Kubera's Fast Forward planning feature is a game-changer. It allows investors to simulate future financial scenarios by applying customizable rules to their portfolio. This forward-thinking approach is crucial for adapting to market changes and personal financial goals.
• Real-time Reporting and Analytics: With Kubera, you can effectively manage and mitigate the high volatility associated with leveraged ETF bonds. You can see a snapshot of your daily returns, past performance, YTD investment returns, and total returns. You can also see your portfolio diversification, asset allocation, and risk profile. Kubera can help you make informed and confident decisions about your leveraged ETF bond portfolio.
• Comprehensive Wealth Building and Protection: Kubera's beneficiary management feature enables users to designate a beneficiary for their financial data and assets. It provides a secure and automated process, including a "Life Beat" check workflow, to ensure beneficiaries receive access only when necessary. Users can also store critical financial and estate planning documents, making sure all essential information is passed on. This feature includes setting a contingent beneficiary, offering additional security and peace of mind.

Kubera is the ultimate solution for high-net-worth investors who want to manage their leveraged ETF bond portfolio, and more. Kubera can help you navigate the complex and dynamic world of leveraged ETF bonds, and make big-picture financial pictures.

Sign up for a trial today, and see for yourself how Kubera can transform your wealth management experience.