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WisdomTree lists five rules for short & leveraged ETPs

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WisdomTree has published a list of five things it believes investors should understand before investing in short & leverage ETPs.

The firm writes that leverage has been around for hundreds of years and, today, there are many different types of short and leveraged instruments – from notes, to funds, to certificates – listed on exchanges globally.

“Because of the combined features of leverage and daily compounded returns, these types of trading instruments can enhance returns and be a robust, transparent, secure and cost-effective trading tool,” the firm says.

1.      Leveraged returns allow an investor to magnify the returns (positive and negative) of an unleveraged investment.

2.      Leveraged products allow investors to either use less of their capital to achieve a desired level of exposure, or to magnify their exposure using the same amount of capital.

3.      There’s a reason why ETP providers incorporate rebalancing (which is usually daily).

Leveraged ETPs seek to offer a stated multiple (that is, the leverage factor) of the performance of their benchmark over a period of time.
This period of time is typically one day. This means that leveraged ETPs need to rebalance the leverage at the end of each trading day to ensure they offer investors the same leverage factor on each new trading day. If weekly or monthly leveraged was used, the exposure for investors would depend on what day of the week or month they bought the investment and would change with the movement of the underlying index.

Over time, this may lead to extreme results (for example, exposures greatly in excess of the stated leverage factor). Since ETPs are open-ended and can be created and redeemed daily, daily rebalancing allows investors to buy and sell the ETP on any date and still receive the stated leverage factor.
 
4.      Compounding needs to be taken into consideration for ETPs held over periods longer than one day and can have both negative and positive effects.
 
 
5.      Different ETP providers and instruments offer varying degrees of protection for both your initial capital and consequent losses (or gains).

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