As investors, we're always on the hunt for the best returns. Well, one Aussie exchange-traded-fund (ETF) has managed to gear up ASX returns by more than 100% since the COVID-19 crash. This is pretty mind-boggling, considering its holdings mirror the ASX 200. So, what's the secret?
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Leverage magnifies ASX returns… and risk
The last 15 or so months have been golden for investors going long on the ASX share market.
If you had invested in the S&P/ASX 200 Index (ASX: XJO) at the very bottom of the COVID-19 crash on 23 March 2020, you'd have returned 61.6%, which is not to be sneezed at.
However, BetaShares Geared Australian Equity (Hedge Fund) (ASX: GEAR) took the recovery returns to a whole new level. In the same time frame, the leveraged ETF has increased 182% in value, significantly outstripping the benchmark index.
But how? The difference is a thing called leverage. It's the same as when buying property – most people take out a loan so they can purchase a higher dollar-value property. Leverage in the stock market is essentially the same – but instead of a house, it's ASX shares.
It's important to note, applying leverage magnifies both returns and losses. If the benchmark index falls, a leveraged investment will fall more. And whether you're making money or losing it, you'll still have to pay interest on the loan amount.
According to BetaShares, one advantage of its GEAR ETF is the lower cost of borrowing. The fund makes this possible by using its size to borrow at cheaper rates than those available to individuals. This cost is wrapped into the 0.8% per annum management fee charged.
Not everyone is a fan
Despite delivering market-beating returns since the crash, not everyone is cheering for leveraged ETFs. In fact, Stockspot founder Chris Brycki thinks they shouldn't be classed as ETFs at all:
I don't think they should be classed as ETFs, they are basically dangerous structured products. Even if you get the direction right, these are terrible products to use because the compounding of daily returns makes them not appropriate as investments.
Even BetaShares managing director Alex Vynokur advises leveraged ETFs should not be used as a standalone investment. Instead, he says the product could be considered more of an insurance policy within a diversified portfolio.
