An Ultra ETF employs leverage with the aim of delivering returns that are higher than the benchmarked returns. This class of exchange-traded funds arrived in the financial market in 2006, and since then it has grown to include a variety of ETFs who’s underlying indexes include major indexes such as Russell 2000 and the S&P 500. These diverse ETFs included in an ultra ETF may also belong to specific sectors such as healthcare, materials, and technology.
Leveraged funds and geared funds are the other names of Ultra ETFs.Highlights
Exchange-traded funds track the exchanges and invest in the securities included in a specified index. The main aim of an ETF is to generate returns resembling the returns offered by the underlying index by copying the holdings of the index and allows the investor’s returns to mimic the performance of the equity market in a broader sense. ETFs offer complete exposure to a particular industry or sector.
Traditionally, the ETFs are meant to replicate the underlying or benchmark index on a one-on-one basis, that is, if the underlying index moves up by 0.5% then the ETF also move up by 0.5%. On other hand, the Ultra ETFs can be categorised as ETFs that are more aggressive in nature. They desire not only to match the underlying index but to amplify the returns offered by the benchmark. To do so, these securities include debt and financial derivatives to amplify the returns by two, three or 4 times. The amplification is also dependent upon the performance of the underlying index as well.
In the case of Ultra ETFs, having high daily volatility is both dangerous and beneficial for the investors. Ultra ETFs are most suitable for short-term investing and maximising returns in a short span of time, because of their high-cost structure and high risk nature.
In a flat market, the Ultra funds might not be able to generate double funds as per the prospectuses. Moreover, the divergence from targeted performance can be observed in the long-term returns as well.
The only aim of the ultra ETFs is to amplify returns on daily basis, and it is achieved by applying their analysis in a very short span of time.
An investor’s analysis indicates that a particular index will show a jump in the share prices in the coming days, then the investor might want to explore all the opportunities to convert his/her analysis into large future profits. Ultra ETF is one of the alternatives that can be adopted by the investor to earn extensive profits.
Ultra ETF might be more suitable than other options as there is no stress of trading on the margins (a process in which funds are lent to the customers by the brokers and securities are kept as the collateral) and no additional cost is incurred.
Tactical investors are most benefited by the Ultra ETFs as they are short of funds or do not have space to diversify their existing portfolios.
The major limitation is that Ultra ETF is a double-edged sword because of the presence of leverage. Here, it means that leverage can generate significant returns if the prediction is right, and at the same time it can incur significant losses if the market goes another side of the prediction. The leverage magnifies the return, no doubt, but it also magnifies the standard deviation that makes these investments riskier, when compared to the non-leveraged ETFs that have a similar benchmark index, sector or industry. Thus, these investments are not suitable for new or average investors.
Ultra ETFs are also not suitable for those investors who are looking for long-term investment or looking for buy and hold opportunities. This investment requires daily compounding and rebalancing, combined with leverage. It results in diverging the investment returns from the expectations over time. Wide variance is present in the performance, and the standard measures are irrelevant here.
Lastly, the payoff of the investment is significantly affected by the charges associated with it. Ultra ETFs are highly complex and include the usage of borrowed funds, resulting in more expenses in comparison to the traditional ETFs. The expense ratio of an Ultra ETF is 1% or more, whereas the expense ratio of a standard ETF is usually 0.5% only.
Ultra ETFs are used in the debts and financial derivatives to increase the returns by offering double, triple or sometimes price movement from the underlying index.
Generally, Ultra ETFs can turn out to be highly useful for tactical investors. These investors are short of funds to leverage their position in the market, or they lack the allocation space. If a tactical investor invests 10% of their existing portfolios, then they will gain approximately 20% of the exposure because of the leverage extended by Ultra ETFs.
Ultra ETFs form a small part of the ETF universe, whose value is approximately $50 billion. Ultra ETFs allow the investors to amplify their investment by betting or shorting against the benchmark or underlying index.
The performance of the Ultra ETFs is dependent upon the performance and movement of the underlying index and numerous pros and cons are associated with it. For instance, new investors or inexperienced investors should not invest in Ultra ETFs as it is only for the professional ones as a high amount of risk is associated with it. It is only useful for short term hedges and tactical strategies. It may tempt investors because of the investment’s potential to extend a high amount of returns.
In inverse leverage funds, investors make a profit when the benchmarked index declines or move in the opposite direction. The value of the inverse Ultra ETFs increases when there is a downward movement of the underlying index, that is, the investor only makes a profit in the bearish market.