DIY Investor Magazine
/
December 2015
58
WHAT INDICES DO SL ETPS TRACK?
Short and leveraged 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.
HOW IS THE SHORT AND LEVERAGE POSITION
ACHIEVED?
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.
DAILY RE-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 using margin 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 leverage
multiple. 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 could be used
but then the actual leverage an investor was exposed
to would depend on what day of the month they bought
the investment. Daily leverage simplifies this issue.
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 many months).
Daily leveraged exposure means the compounding
effect is amplified and occurs 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 3UKL will rise by 3% to £103; if the FTSE 100 then
falls by 1% the next day 3UKL will fall to £99.91.
Thus over the two days the average return is 0% but 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 return -
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 “Volatile Market” chart the index moves
up and down by 2% per day.
After 11 days, the Index is up by 1.8% the 3UKL would
be up only 4.1% (2.3x the Index) and the 3UKS is down
7.7% (-4.3x the Index).
The “Trending Market” 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 3UKL
would be up 89.8% (3.7x the Index) and the 3UKS 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.
VOLATILE MARKET
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
CUMULATIVE RETURN
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
DAILY RETURN OF INDEX
