Some of you might have heard about ETFs (Exchange Traded Funds) before, and only a few of you might have heard of ETP’s (Exchange Traded Products).
ETFs or exchange-traded funds are familiar concepts in India. However, ETPs are exchange-traded products, and ETF is actually a subset of an ETP. Globally, ETFs account for 97% of all exchange-traded products. However, for an investor, it is essential to know the difference between ETP and ETF.
OVERALL, the ETP market is worth nearly $5 trillion, of which nearly $4.8 trillion is accounted for by ETFs alone. ETFs are plain vanilla, traditional passive funds. On the other hand, ETPs are financially engineered investments that bet on or even against the very indexes that they track.
ETFs are like a mutual fund and just manage the money by investing in an index-linked asset class. ETPs are not plain vanilla, but they are normally either long / short products or even leveraged products with borrowing permitted to enhance returns.
Today, we will discuss an Exchange Traded Product that helps experienced investors earn 2x, 3x, and even -1x (inverse) return on their investment. All this can be done without any margin account (and, of course, no margin calls). Obviously, any losses will also be magnified. (P.S. – Experienced Investors only!)
We talk about S&L ETP (Short and Leveraged Exchange Traded Product) by a leading European Firm – Leverage Shares.
Leverage Shares is a European leader in leveraged and inverse exchange-traded products (ETPs), offering experienced traders magnified exposure, daily investment objectives, and efficiency when buying stocks on leverage. They are the only provider in Europe that offers physical replication of single-stock ETPs.
Leverage Shares offers a solution in the form of single-stock short and leveraged exchange-traded products (S&L ETPs). These ETPs are built around some of the most heavily traded US tech and finance stocks, which collectively account for a quarter of the S&P 500 and nearly half of the Nasdaq 100. The products include names like Amazon, Apple, Microsoft, Tesla, and others – offering both leveraged (2x and 3x) and short (-1x) exposure to individual equities.
How does it work?
The company offers three leveraged products, i.e., the 2x, 3x, and the -1x ETP.
Example 1: We will consider “Leverage Shares 3x Amazon ETP” for our case.
Objective of the ETP: 3AMZ tracks, excluding fees and other adjustments, the performance of the Solactive Daily Leveraged 3x Long Amazon Index (the Index).
Objective of the index: The Index seeks to provide 3 times the daily performance of Amazon’s share price.
|3 November 2020||4 November 2020||% variation|
|Amazon share price||$3,048.41||$3,241.16||+6.32%|
|iSTOXX Leveraged 3x Amazon Index||146,850 points||174,697 points||+18.96%|
|Leverage Shares 3x Amazon ETP||$25.59||$30.44||+18.96%|
Example 2: We will consider “Leverage Shares -1x Netflix ETP” for our case.
Objective of the ETP: -1NFLS tracks, excluding fees and other adjustments, the performance of the Solactive Daily Leveraged 1x Short Netflix Index (the Index).
Objective of the index: The Index seeks to provide -1 times the daily performance of Netflix’s share price.
|11 January 2021||12 January 2021||% variation|
|Netflix share price||$510.10||$494.99||-3.05%|
|iSTOXX Inverse Leveraged -1X NFLX Index||38.63 points||39.80 points||+3.05%|
|Leverage Shares -1x Netflix Daily ETP||$14.732||$15.182||+3.05%|
I am sure that with the above two examples, you might have clearly understood what these products actually are. We have a product through which we can take leveraged exposure on the stocks on which we have high conviction; isn’t it cool?
Daily Compounding of ETP’s
In the hypothetical example below, we are considering a 2x Leveraged ETP in an upward trending market, where the underlying stock rises 5% every day. Starting from day zero with an investment of $100, the 10-day performance would be as thus:
It can be seen that the daily compounding formula adds nearly 33% in gains over a 10-day period when compared to expectations of a 2x investment in the underlying asset.
During days with choppy markets, the continuous oscillations would have a negative impact on the leveraged ETP’s performance. Assuming a rise of 5% in a single day followed by a drop of 5% in the next would result in a 10-day performance as follows:
From these illustrations, it can be summarised that when it comes to leveraged ETPs, “the trend is your friend”.
While I really liked the product, I had a few questions regarding the working of this product. I reached out to Mr. Oktay Kavrak, Product Strategy at Leverage Shares, and was fortunate enough to get all my queries cleared. Below is the transcript of the chat.
Nikhil Bhauwala – Buying shares directly on leverage can also solve the purpose. How is this product different from buying shares directly on leverage?
Oktay Kavrak – Unlike traditional methods to achieve leverage, we don’t require margin account to trade and losses are capped to initial investments. No investor can lose more than their initial investment. Consider a covid-19 scenario; the coronavirus brought to the forefront a long-standing concern in their relationship with financial institutions: the potential downside of a margin call. When stock markets plunged by over 25% at the beginning of 2020, banks and wealth managers were compelled to liquidate investors’ positions in the face of margin calls, imposing heavy losses on the latter. We make sure that investors in our product will never have to go through this, ever.
NB – Well, that’s really innovative and this probably changes everything. But, how do Leverage Shares ETP achieve their leverage? Is there any credit risk involved?
OK – Leverage Shares Exchange Traded Products are debt instruments issued by a special purpose vehicle (SPV). Each ETP is a separate Series of the SPV, and is a debt security that delivers the returns of the assets held by the Series. Each Series invests its own assets and the assets borrowed on margin in a single stock, such as the common stock of Apple Inc. (AAPL), to achieve leveraged exposure to that equity as per its investment objective.
- Exposure to the underlying stock is managed to deliver two times the return (gain or loss) of the underlying stock on a daily basis (net of fees and expenses)
- Leverage Shares do not have credit risk because each Series of the SPV has physical ownership of the underlying assets and does not use derivatives, like swaps, to achieve its leverage
- Each ETP is fully collateralized, as its subscription proceeds are invested directly in shares of the underlying equity security, effectively negating potential credit risk
- Leverage Shares ETPs have access to institutional pricing for margin borrowing, and therefore can be a cost-effective means for investors to gain leveraged exposure to individual stocks
This is about democratizing access to strategies once reserved for fund managers, like trading with leverage and going short.
NB – Whoa! That’s great. Now let’s talk about monies! What are some fees & costs associated with investing in Leverage Shares ETPs?
OK – All product costs are detailed in the relevant exchange-traded product (ETP) FactSheet and KIDs, which are available on each individual ETP page. Generally, the following fees are applicable:
1. Arranger Fee: Charged daily, annual rate of 0.75% of the ETP Value held by security holder;
2. Daily Margin Interest: Designated benchmark rate + 1%*.
1. Arranger Fee: Charged daily, annual rate of 0.75% of the ETP Value;
2. Securities Borrowing Fee and Interest on Cash: The current Securities Lending Fee is published on leverageshares.com on a daily basis).
NB – It certainly is much cost-effective when we compare it with traditional methods. Lastly, Do Leverage Shares ETPs pay dividends?
OK – No. Leverage Shares uniquely replicates the payout of its ETPs physically, so it holds the stocks underlying its leveraged ETPs and receives the dividends on such stocks. However, such dividends are reinvested in more shares of the underlying stock.
NB – Thank you Mr. Oaktay for your time, it was good to have you. It indeed is a great product, especially for people who are experienced investors and are looking to increase their returns and lower their costs and risks. I hope Leverage Shares keep engineering new and innovative financial products that benefit the investor. I really wish if we could have such products in India.
We really liked the concept of ETP on popular individual US securities. This product ensures that investors don’t need a margin account for leveraging shares, their maximum loss is limited to the amount they have invested, and all this can be done at a very low cost. You can visit their website at https://leverageshares.com to know more about their products.
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