Double the chaos: Amped-up funds flourish amid turmoil

NEW YORK, N.Y. – That second scoop or slice makes everything so much better. So why not double the fun investing, too?

Investors in search of supercharged returns are plugging more dollars into investments that aim to give double or even triple the daily returns of boring old index funds. But even the companies behind these investments warn that they’re not for everyone.

The industry calls these investments leveraged funds, and they use futures contracts and other trading techniques to amplify gains — and losses.

“They’re not for mom-and-pop investors,” says Michael Sapir, chief executive of ProShare Advisors, one of the biggest players in this niche of investing. “These are advanced portfolio tools to incorporate into an advanced, constructed portfolio.”

The main pitfall is that long-term returns for these thrill-ride funds can be different or even opposite from what you’d expect, because they are built to take advantage of daily market moves instead of longer trends. If the S&P 500 index is up 10 per cent in a month, a double- or triple-index fund probably won’t return 20 per cent or 30 per cent. It could even lose money if markets are particularly volatile, like they are now, and big losses come early and are followed by smaller daily gains.

Leveraged funds still occupy only a small corner of the investing world, but their growth is accelerating.

Altogether, leveraged funds controlled about $22 billion at the start of the year, according to Morningstar. That’s less than one-fifteenth the size of Vanguard’s Total Stock Market Index fund, the largest mutual fund. But interest in them is growing. Leveraged mutual funds and exchange-traded funds drew $5.3 billion in net investment last year, more than technology-stock funds did. It’s also a step up from the $819 million that leveraged funds attracted a year earlier.

A separate group of funds, ones that allow investors to bet against an index and get double or triple the return, attracted another $1.3 billion last year. So when the S&P 500 falls 1 per cent in a day, the ProShares UltraPro Short S&P 500 ETF aims to return a positive 3 per cent, before fees.

The lure of these funds is easy to see: They can offer big returns very quickly, even though they charge higher fees than traditional index funds.

The best-performing ETF this year is the Direxion Daily S&P Biotech Bear 3x fund, for example. It tries to give the opposite daily return of a biotech stock index, tripled, before fees and expenses. It has surged nearly 200 per cent in 2016.

But the magic of compound interest, such a friend to buy-and-hold investors in traditional funds, can trip up novice investors in these funds.

Most of these leveraged funds are built with one day in mind: They offer double or triple the daily return of an index. That means these leveraged funds reset after each day, and they’re not trying to offer double or triple the long-term returns of an index.

If markets are swinging wildly, the compounding effect can muddle longer-term returns. The S&P 500 returned 1.4 per cent last year, including dividends, for example. But the ProShares UltraPro S&P 500 ETF, which aims to triple the index’s daily return, lost 5.2 per cent last year.

Funds that bet against indexes get caught up in the same math. The ProShares UltraPro Short MidCap, for example, tries to give the opposite daily return of a mid-cap stock index, tripled, before fees. So when the S&P MidCap 400 index lost 2.2 per cent in 2015, a novice investor may have expected a gain for the inverse fund. Instead, the ETF lost 7.6 per cent.

Some investors in these funds, including hedge funds and individuals, are looking for a quick, big score. Last year many investors were looking to call the bottom for oil and then not only benefit from its rebound, but get multiples of it. ProShares’ most popular leveraged ETF last year was its Ultra Bloomberg Crude Oil fund, which tries to give double the daily performance of an oil index. It attracted $1.2 billion in net investment.

Other investors are looking to buy protection for their portfolios in case some investments fall. ProShares had several ETFs that drew more than $150 million last year, ones that rise when prices fall for everything from the S&P 500 to emerging-market stocks to high-yield bonds.

Experts say investors in these funds should check on the holdings at least every day. Companies that sell them have for years had pages of warnings on their websites, explaining how the math of compounding returns can steer results in potentially surprising ways.

So, has the message gotten through? Does everyone who is in a leveraged fund now understand all the risks?

“Everyone is a pretty high standard,” says ProShares’ Sapir. “But our experience is that the users of the product tend to be a knowledgeable audience. They generally know what they’re buying and how the funds operate.”