Frequently Asked Questions about Geared Funds
Geared (leveraged and inverse) funds, which seek to provide a multiple (e.g., 2x or -2x) of the daily returns of an index or benchmark, have become valuable tools for knowledgeable investors seeking to implement a wide variety of investment strategies. With the nation’s largest lineup of alternative ETFs1 and as the leader in geared2 funds, ProShares is committed to providing information to help investors better understand how these funds work, so they can make informed investment decisions. Below are answers to frequently asked questions about geared funds:
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Geared funds, also called leverage and inverse funds, are designed to provide a multiple of the performance of a benchmark. A leveraged fund is designed to provide a multiple (e.g., 2x or 3x) of the return of an index or other benchmark, usually for a single day, before fees and expenses. An inverse fund is designed to provide a multiple of the opposite (e.g., -1x, -2x, -3x) of the return of an index or other benchmark, usually for a single day, before fees and expenses.
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Geared funds are valuable tools that can be used in a variety of ways by knowledgeable investors. Some examples include:
- Pursuing magnified returns (of course, losses are also magnified).
- Getting a target level of exposure using less cash.
- Helping to hedge against expected decline.
- Fine-tuning exposure (e.g., using an inverse fund to reduce exposure to a sector without selling holdings).
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Geared funds are used by knowledgeable investors who are familiar with the specialized benefits and risks associated with these types of products, and who have an understanding of investment concepts and practices (
Considerations for Geared Investing). Shareholders, or their advisors, should be prepared to monitor their geared fund positions closely, as often as daily, and should use them as part of a diversified portfolio.
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Geared funds can invest in a number of different securities and financial instruments, including stocks, bonds, swaps, futures and forwards. ProShares leveraged ETFs have historically held a significant amount of individual stocks or bonds, and have used swaps, futures, forwards and other instruments to achieve the remainder of their target exposure. ProShares inverse ETFs have historically gotten their exposure through swaps, futures and forwards, and have not shorted individual securities. For more information, see
Components of Geared Funds.
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Many factors can affect the performance of geared funds over time, including compounding, a mathematical concept that affects the returns of all investments. It is important for investors to understand how
compounding affects the returns of investments under differing market conditions, including upward-trending, downward-trending and volatile markets. Geared fund investors should understand that the effect of compounding on geared funds is magnified, and can cause gains and losses to occur much faster, and to a greater degree, than the returns of investments that are not geared. Four factors significantly affect how close daily compounded returns are to longer-term index returns times the fund's multiple: (1) the length of the holding period, (2) index volatility, (3) whether the multiple is positive or inverse, and (4) its leverage level.
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Resetting exposure in a geared fund each day means investors can start with the level of exposure stated in the fund's objective, on any day they invest. If geared funds did not reset their exposure each day, the actual multiple of their benchmark's return would vary each trading day because of
compounding. The exposure of a fund to its benchmark, over time, could easily become very small (e.g., less than 1x or greater than -1x) or very large (e.g., more than 10x or less than -10x). It is not possible for an open-ended fund that does not reset its exposure each day to provide a specified multiple of a benchmark return regardless of the time period the geared fund is held. See "
Geared Fund Performance" guide for more information.
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No. The investment objective of most geared funds is to seek a multiple of an index return for a single day. Geared funds can also be used for longer periods, but the return of the fund can be significantly different than the index return times the fund multiple. Investors seeking returns for periods longer than a day that are closer to the index return times the fund multiple should monitor their investments and
rebalance as needed. An investor's time horizon may be based on many factors, such as market outlook and risk tolerance. Investors may need to rebalance more frequently in funds with higher index volatility, inverse multiples and greater leverage. A rebalancing strategy will involve transaction costs and can generate tax consequences. Rebalancing does not guarantee specific future results and may result in investment losses.
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Yes. Academic research
2 conducted on 2x and -2x multiples supports the idea that a basic rebalancing strategy for leveraged and inverse funds may help an investor to achieve returns close to 2x or -2x the index return over time. This rebalancing strategy uses a calculation to determine the amount to add to or reduce the investment in a leveraged or inverse fund, such that the investment exposure held is in line with the targeted return for the period.
Rebalancing can be performed at fixed time periods (e.g., weekly or monthly), or it can be triggered when a specified return threshold is reached. Investors may need to rebalance more frequently in funds with higher index volatility, inverse multiples and/or greater leverage. A rebalancing strategy will involve transaction costs and can generate tax consequences. Rebalancing does not guarantee specific future results and may result in investment losses.
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Geared funds can be used to implement a variety of short- and longer-term strategies. For instance, an investor may choose to hold a longer-term position in a geared fund based on a view that the index will trend upward or downward in a low-volatility environment. If the investor is correct, this could result in geared fund performance higher than the index return times the fund multiple. However, if incorrect, a geared fund's returns could be lower—perhaps significantly. Investors should be prepared to monitor their geared fund positions frequently, as often as daily.
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Our
resources page has a number of educational materials, including:
1 Source: FRC, as of March 31, 2012
2 Source: Lipper, based on a worldwide analysis of all known providers of funds in these categories; the analysis covered ETFs and ETNs by the number of funds and assets, as of June 30, 2012