The Horizons BetaPro “Plus” ETF products have been getting some positive press lately with Jonathan Chevreau writing, Looking for shelter in a bear market, Rob Carrick writing, Bear’s best friend: an ETF to profit from bad times, and Don Vialoux writing, Lure of leverage gives boost to new ETFs. These products attempt to provide two times the daily exposure to a given index using derivatives such as total return swaps and futures. Here are my comments on this product:
- The leverage employed is 2X daily exposure. This is very different from buying stocks on margin in your own account. For example, if you borrowed $100 to buy $200 worth of stocks, as the value of the stocks (the assets) goes up your position naturally delevers. Conversely, as the value of the stocks goes down, your position levers up. These ETFs rebalance every day to ensure you have a constant leverage of 2X–again, every day. I’ve tried to illustrate the dynamics of this using a numerical example (see the attached tables below).
- Executing this strategy well is not easy and it’s a certainty that the managers will not achieve perfect correlation or negative correlation with the reference index. I looked at the daily returns between the S&P/TSX 60 Bear Plus (the fund that Carrick wrote about) and 2X the negative of the S&P/TSX 60 (for the period between April 2, 2007 to June 28, 2007). The correlation was about 0.74 with a daily tracking error of 1.154%–about 18.319% annualized!
- This leverage doesn’t come for free. While the leverage through derivative exposure is cheaper than what you could achieve in your personal margin account, these derivatives still have financing rates baked into the pricing models and have a bid-ask spread like every other financial instrument.
- An MER of 1.15% seems like a lot of money.
Numerical Example:
4 responses so far ↓
1 Anonymous // Jul 17, 2007 at 8:06 am
Daily correlation to underyling index has been near perfect (0.99 or -0.99). Please provide an email address and we would be happy to provide the data and analysis.
2 investskeptically // Jul 18, 2007 at 9:49 am
Anonymous: I sent you an email to your return address but got no response. My email is thomas @investskeptically.com. I’m very interested in seeing your data and analysis. Thanks for your feedback.
3 ThickenMyWallet // Jul 20, 2007 at 5:08 pm
Thanks for the analysis. I wanted to piggy-back on two comments you made:
1. If the purpose of this product is for retail investors, can it be explained easily enough or is this in the same vein as PPN? It sounds great but how many people can actually describe how it works?
2. 1.15% MER on what is supposed to be a low-fee product- is this a harbinger of creeping fees on the ETF product line?
4 investskeptically // Jul 21, 2007 at 5:21 pm
ThickenMyWallet: Thanks for your comments.
(1) I think in some ways it’s not too conceptually difficult to explain in that the leverage is not really ‘hidden’. But any explanation would require understanding how the relevant derivative instruments work.
(2) You’ve raised a good point. As we get more funky ETF products (narrow indices, custom indices, leveraged, etc.) coming to market I think they will all have higher fees than we’re used to seeing on something like XIU.
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