Should you invest in Geared ETFs?

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Borrowing to invest has always promised the potential for higher returns. Now, a new generation of geared ETFs is making it easier than ever for investors to access leverage with the click of a button...

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Now, a new generation of geared ETFs is making it easier than ever for investors to access leverage with the click of a button...</p>\n\n<a href=\"https://www.morningstar.com.au/etfs/should-you-invest-geared-etfs\">Source Link</a>\n\n</div>\n\n\n</article>\n</div>\n</body>\n</html>\n","isBrief":false,"type":0,"news_type":1,"symbol":"QQQP","symbol_name":"Tradr 2X Long Innovation 100 Quarterly ETF","start_time":0,"source_url":"https://www.morningstar.com.au/etfs/should-you-invest-geared-etfs","article_id":"2654765690","we_media_id":null,"thumbnails":[],"rights":{"source":"morningstar_stock","url":"https://www.morningstar.com.au/etfs/should-you-invest-geared-etfs","rn_cache_url":null,"directOrigin":true},"url":"https://stock-news.laohu8.com/highlight/detail?id=2654765690","pubTimestamp":1785168000,"columns":[],"sourceInfo":{"source_id":"morningstar_stock","name":"Morning Star"},"weMediaInfo":null,"summary":"Borrowing to invest has always promised the potential for higher returns. Now, a new generation of geared ETFs is making it easier than ever for investors to access leverage with the click of a button.But are these products as straightforward as they seem?LaMonica: Ben. Our team took him out for some Korean barbecue, which was excellent. We made Will cook everything, because Will…Jayamanne: I tried to help, but then I got bored halfway through.LaMonica: Yes.Jayamanne: He liked got me to a grill of my own, and half an hour in, I was done.LaMonica: Yeah. Well, Will enjoys doing it. So, we had Will cook. But Ben has – how do we want to describe?Ben has a lot of tattoos.Jayamanne: He has a lot of tattoos. 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Now, a new generation of geared ETFs is making it easier than ever for investors to access leverage with the click of a button.But are these products as straightforward as they seem?In this episode, Mark and Shani unpack how geared ETFs work, why they’ve become one of the fastest-growing areas of the ETF market, and the risks that many investors overlook.The discussion explores why leveraged investing doesn’t simply produce ‘double the returns’, the hidden impact of volatility decay, how different gearing structures affect investor outcomes, and why these products are designed very differently from traditional long-term ETFs.The episode also looks at the rapid rise of single-stock geared ETFs overseas, what their growing popularity says about investor behaviour, and whether they could contribute to greater market volatility during periods of stress.Whether you’re considering a geared ETF yourself or simply want to understand one of the fastest-growing trends in investing, this episode explains the mechanics and the trade-offs.Find more articles on Geared ETFs here:Young & Invested: Why these ETFs might require caution. Investigating a high risk, high reward approach to ETF investing.The promise and perils of geared ETFs. Many investors don’t understand how a geared ETF works and may be disappointed by the results. You can find the transcript below:Shani Jayamanne: Welcome to another episode of Investing Compass. Before we begin, a quick note that the information contained in this podcast is general in nature. It does not take into consideration your personal situation, circumstances, or needs.Mark LaMonica: So, Shani, we had a big night last night with the team. Unfortunately, somebody that we’ve worked with for a very long time is leaving.Jayamanne: Ben?LaMonica: Ben. Our team took him out for some Korean barbecue, which was excellent. We made Will cook everything, because Will…Jayamanne: I tried to help, but then I got bored halfway through.LaMonica: Yes.Jayamanne: He liked got me to a grill of my own, and half an hour in, I was done.LaMonica: Yeah. Well, Will enjoys doing it. So, we had Will cook. But Ben has – how do we want to describe? Ben has a lot of tattoos.Jayamanne: He has a lot of tattoos. What is the particular genre of punk that he partakes in?LaMonica: I don’t know. I think I know, but I don’t want to sound like an idiot guessing.Jayamanne: Okay.LaMonica: But anyway, a (typee) is in a band.Jayamanne: Yes.LaMonica: And so, we dressed up for the occasion.Jayamanne: We did. We tried to dress with lots of tattoos, temporary.LaMonica: Yes, we did not all get tattoos. But anyway, good night, lots of soju. So, we’re going to try to get through this. But today’s topic – we got an email from a listener named Michael. And Michael asked a couple questions, but one of the questions he asked was about leveraged ETFs. And it’s a great topic because gearing has been in the news a lot lately, Shani. And we’ve had all the commentary around the budget. There is no longer negative gearing on non-newly constructed residential property in Australia, obviously purchased after the budget. You can no longer borrow money in a self-managed super fund to go out there and buy residential property. So yeah, gearing has been in the news a lot.Jayamanne: Yeah, but there is still one very easy way to borrow money to invest, and that is through a geared ETF. There are other ways to borrow money to invest in the share market, but by far the easiest is through these ETFs, which you can easily purchase through your broker. To start off, Mark, can you just describe the basics of these products and we can get into a bit more detail later?LaMonica: Absolutely. So anytime you borrow money to invest, so this is for property, this is for shares, for anything, the upside and the downside of any return outcomes are amplified. So, imagine a scenario where you invest $100,000 and $50,000 of the funds are borrowed. That $100,000 investment grows by 10%. It’s now worth 110,000. You’ve only invested $50,000. So that 10% or $10,000 gain really is a 20% gain for you. So that is the return, and then you want to take away obviously any expenses associated with borrowing the money. So, a geared ETF basically does all that for you. It borrows the money to invest for you.Jayamanne: So, a geared ETF that tracks the ASX 200 would amplify the returns of the index minus the cost of borrowing the money. The level of gearing will drive how much the returns on the upside and downside are amplified.LaMonica: Okay. So conceptually, that is quite simple. There are a lot of complexities when you get into the details. We will do that during this podcast, but we do want to spend a little time on the context. I said that Michael’s email came at a timely time because there’s a lot of news about geared ETFs right now and what’s happening with them both globally and in Australia.Jayamanne: Yeah, investor interest globally in geared ETFs is exploding as a result of ETF providers. They’re releasing more and more products. And in the last six months, the assets in geared ETFs in the US have increased by 55% to $198 billion.LaMonica: And we gave that example of a geared ETF that tracks a broad-based index. So, we use that ASX 200 example. But in the US and other countries, there are single security geared ETFs. So, while a normal ETF holds a basket of securities, the single security geared ETFs will borrow money and invest in a single share, like NVIDIA.Jayamanne: Since January 2025, 275 geared single stock ETFs have launched in the US. And according to Reuters, single stock ETFs now account for approximately 8% of the total trading volume in the US.LaMonica: And this will surprise a lot of people. It will certainly surprise you, Shani. For once, the US is not the craziest place in the world. So, for that, we need to turn to South Korea. In April, so not very long ago, single stock ETFs were introduced. And over the last several weeks, they’ve made up almost half of the average daily volume in popular shares like Samsung and SK Hynix. And volatility is off the charts in South Korea. And that’s because these ETFs can cause wild swings in the market. So even if you have no interest in geared ETFs, if you don’t want to buy one like me, it is still something that you should know about.Jayamanne: The other point we want to add is that the growth of geared ETFs is showing investors are very comfortable with risk. This risk taking often happens towards the tail end of a bull market. And while increased risk taking can drive the market higher if things start going south, it can amplify overall market losses. We’re not predicting the market will go down, but we do want to make that point.LaMonica: Okay, let’s get into the details now, Shani. So, we said conceptually this is very simple. You invest $1,000 into a geared ETF, the ETF borrows money, invest your money and the borrowed money into something like the ASX 200. And the question that many people ask, and it is a legitimate question, is if the share market goes up over the long term, why wouldn’t you just invest in geared ETFs and get higher returns? If you invest in something offering double the market return and hold for the long term, you’ll get double the return of the market.Jayamanne: And that does seem logical, but unfortunately that isn’t the way that it works. There are several things at play here, including benchmark returns, market volatility, and the cost of borrowing. Volatility plays a major role. So even in rising markets, leveraged ETFs can erode returns by magnifying both gains and losses. And this is referred to as volatility decay. Investor expectations of amplified performance generally don’t materialize as well as many people anticipate.LaMonica: And the kicker is that negative returns have a larger impact than positive ones on a per unit basis, especially when leverage is involved. So, let’s say you’re using a two times geared ETF and the market drops 10%. Your investment falls by 20%, turning $100 into $80. To get back to $100, you need a 25% gain, not just the original 20%. And we can contrast this with a non-geared investment that drops 10% to $90. That only needs an 11.1% gain to recover. So, in this case, the recovery burden is effectively quadrupled. So, every loss demands a bigger recovery, and gearing makes that recovery harder.Jayamanne: Another factor is how an ETF has to rebalance to maintain the same levels of gearing. The more volatility there is in the underlying investment, the more the ETF provider may have to rebalance to stay within gearing limits. This can reduce exposure during market recoveries and hinder compounding.LaMonica: And geared ETFs are specifically designed for short-term investors. And this is stated clearly in the ETF product disclosure documentation, but many investors just ignore this. That means that over the long term, they aren’t designed to provide the outcomes that many investors expect.Jayamanne: The path of returns matters. These ETFs tend to perform worse than their headline gearing level would imply. Mark outlined a scenario in his article on geared products where over a 10-day period, the underlying investment alternated between 2% losses and 3% gains. The underlying investment return over those 10 days is 4.79%. But for a 2 times geared product, the return is not 9.58%, like an investor may expect. It is 9.12%. For a 3 times geared ETF, the return is not 14.37%. It is 12.92%. So that is what volatility decay is.LaMonica: And another factor that will influence volatility decay is the way in which gearing is achieved. So, this is where we’re going to get into the weeds a little bit. One way to achieve gearing is for the ETF provider to go out and borrow the money. The advantage of this approach is there will be less volatility decay, which means the ETF should track the geared index returns closer. The disadvantage is that there are, of course, interest costs in doing this that may take a bigger cut out of returns. And there may be limits to how much can be borrowed. The lender of those funds may force a reduction of gearing at the ETF provider if there is a sharp market drop.Jayamanne: A different way to achieve gearing is to use derivatives. A derivative is simply a financial instrument whose value is based on the value of an underlying security. In this case, the ETF provider would use futures or swaps or other forms of derivative contracts to achieve the same level of gearing. This typically is used for high levels of gearing, which is for ETFs that are trying to deliver two or three times the return of an underlying index. Costs may be lower than borrowing money, but this is a case where rebalancing may have to occur frequently, which means over the long term, the returns will likely diverge from what is promised on the label than what an investor would expect.LaMonica: And if you are considering one of these products, spend some time figuring out how they achieve that gearing. And we will give a couple examples. So, one example is the Wealth Builder series of ETFs from Betashares. So Betashares Wealth Builder Australia 200 ETF with the ticker symbol G200 offers relatively low gearing at 30% to 40%. And it uses that borrowing technique that we talked about. Meanwhile, the Ultra Long NASDAQ 100 Complex ETF with a ticker symbol LNAS offers higher gearing, so from 200% to 275% of the NASDAQ 100 returns. And in that case, derivatives are used.Jayamanne: In both these cases, you can see the ETF providers are targeting a range of gearing and not a specific number. That arrangement allows them drift without the ETF provider taking some action to align the gearing to a set percentage. Having a range provides greater flexibility for the ETF provider to not constantly have to take action in volatile markets. This can benefit investors, but also means it’s hard to know exactly how an ETF will perform based on the performance of the underlying asset.LaMonica: And the costs on geared ETFs are typically higher than what you would expect to pay for a standard ETF. This makes sense as they are more complex than just tracking an index. For example, the LNAS, the LNAS ETF we referenced earlier has a management fee of 1%. And G200 has a management fee of 0.35%.Jayamanne: And there’s another wrinkle in the costs. We can use G200 as an example. The 0.35% is equivalent to the costs on the gross asset value of the fund, but it is 0.59% of the net asset value. The net asset value is what you care about because that represents your investment in the ETF. If you put $100 in an ETF and the ETF borrows $50, the gross asset value is $150. But what you care about is a fee on your investment, which is a higher figure of 0.59%. This will shift as the gearing level shift with that range.LaMonica: There’s one more topic we want to address, Shani. So that was a lot of detail.Jayamanne: Yes.LaMonica: Well, we’ve got one more topic, and that’s one of the things that we do focus on frequently on this podcast, and that is investor behavior.Jayamanne: We do. And it’s important that we address the impact of additional volatility of geared ETFs and what that can do to investors. And we’ve talked a good deal about Morningstar’s Mind the Gap study on this podcast. But as a reminder, this study quantifies the impact of poor investor behavior on returns. And while each time we do this study, there is a consistent shortfall in returns that investors get from poor timing decisions, another thing is clear – how volatility impacts the decision making.LaMonica: And the summary is that more volatility means that there are worse decisions made by investors. And that is true for both asset classes, so like shares, where that gap is bigger than bonds, which have lower volatility, and also periods of time when there’s more volatility. And the classic example we always use because people remember this is 2020. So, the gap doubled from close to 1% in 2019 to close to 2% in 2020. And that was all that volatility around COVID.Jayamanne: And there are two implications for investors in this data. The first is if you choose to hold these geared ETFs, you need to be aware that the amplification of returns and volatility cause most investors to behave poorly. Hopefully the self-awareness can help you to avoid this trap, but also make sure you have the right structure in place of having goals and an investment strategy to reduce this risk.LaMonica: And then the second implication is if you avoid these products but are just a regular investor, this could cause heightened volatility in the market as they become more popular. So, the more investors that hold these products, the more likely it is that they will sell if the market drops, which will of course cause the market to drop even more. In times like today, when investors are piling into these products and the market is going up, it’s more likely a bubble will form where prices no longer reflect the value of the underlying market.Jayamanne: And this is particularly true with single stock geared ETFs. In Australia, single stock ETFs are not banned by ASIC, but at least so far there aren’t any. However, if you are investing in individual shares in the US or Korea, you might see heightened volatility. Just keep that in mind. That means that price movements in individual shares may have less to do with the fundamentals and more to do with the upside and downside pressures put on them by investors who are reacting to volatility.LaMonica: And like any investment, the key is to focus on your goals and how that particular investment aligns with what you’re trying to achieve. So different investors will come up with different answers when it comes to geared ETFs. What any investor that is considering a geared ETF needs to understand is how the product works.And that’s what we’re hoping to do on this podcast. So, thank you very much for joining us. Michael, thank you for your question. Any other questions, episode requests, you can send them through to my email which is in the podcast notes.(Disclaimer: Any advice in this podcast is general advice or regulated financial advice under New Zealand law prepared by Morningstar Australasia Proprietary Limited and/or Morningstar Research Limited without reference to your financial objectives, situations or needs. You should consider the advice in light of these matters and any relevant product disclosure statement before making any decision to invest. To obtain advice for your own situation, contact a financial advisor.)Invest Your WayA message from Mark and ShaniFor the past five years, we’ve released a weekly podcast and written on morningstar.com.au to arm you with the tools to invest successfully. We’ve always strived to provide independent, thoughtful analysis, backed by the work of hundreds of researchers and professionals at Morningstar. We’ve shared our journeys with you, and you’ve shared back. We’ve listened to what you’re after and created a companion for your investing journey – Invest Your Way. Invest Your Way is a book that focuses on the investor, instead of the investments. It is a guide to successful investing, with actionable insights and practical applications.If anyone would like to support this project you can buy the book now. Thanks in advance!Purchase from AmazonPurchase from Booktopia","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":false,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"isVideo":false,"video":null,"symbols":[],"gpt_button":0,"need_auth":false,"need_login_tip":false,"code":"91000000","status":"200"},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"isLaohu8Offline":false,"tenantId":"TBGLOBAL","deviceId":"web-server-community-laohu8-v3","version":"4.46.0","shortVersion":"4.46.0","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2654765690","isCrawlerRequest":true}