Over the past two decades, more investment firms have launched leveraged ETFs that aim to double or triple the gains of an underlying stock or index. For example, Direxion's Daily S&P 500 Bull 3x Shares (SPXL 3.53%) aims to triple the daily performance of the S&P 500. Here's what investors should know about these highly aggressive investments.
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If a fund wants to triple the S&P 500's daily return, it usually secures a short-term loan, called a "total return swap," from a bank. If it wants to triple its return with a $100 million investment in the S&P 500, it asks its partner bank to invest $300 million in the index on its behalf.
NYSEMKT: SPXL
Key Data Points
The bank agrees to pay the fund triple the S&P 500's daily gain from that "invested loan", but it collects interest on the entire $300 million loan until the contract expires. This structure is risky, since it triples the S&P 500's return on green days, but also triples its losses on red days.
Furthermore, those gains and losses aren't cumulative; they reset every day. These funds also need to charge high fees to cover their interest expenses. That's why SPXL charges a net expense ratio of 0.87%. These leveraged ETFs might be appealing to aggressive short-term traders, but they're dangerous investments for most long-term investors.
