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Thursday, January 12, 2012

Morningstar Defends Leveraged ETFs

News summary by MFWire's editors

Leveraged ETFs have taken a lot of flak in recent years, especially in the wake of 2010's flash crash. Now, Morningstar's Michael Rawson has penned an article outlining why leveraged and inverse ETFs are not to blame for the increased market volatility.

Rawson notes that while leveraged ETFs use derivatives which are "notorious weapons of financial destruction" and that they are "much more volatile than the underlying indexes that they seek to track," leveraged and inverse ETFs have just $32 billion in assets, accounting for only 3.2 percent of the total US ETF assets.

"It is hard to imagine that such a small segment of the market could impact market volatility," Rawson writes. "Admittedly, leveraged and inverse ETFs do trade more than the average ETF, and at 14%, they account for a disproportionate share of ETF volume. But just as with stocks, most of that volume occurs between individual investors--so-called secondary market transactions--without as much impact on price as a primary market transaction."

The pro-cyclical trading done by leveraged funds also does not cause volatility because, according to Rawson, if this were the case "we should be able to predict the direction of the market in the final minutes of trading based on how the market has moved earlier in the day." 

Edited by: HFD

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