Leverage

A leveraged product is an investment that enhances the growth of the underlying asset over a specified period of time. This strengthening is called the leverage factor. The leverage factor can be both positive and negative. 

Leveraged ETFs might be suitable for investors who firmly believe that the market is moving in a certain direction – irrespective of whether you believe in an upswing or downturn. With Bull, the investment increases in value when the market rises and with Bear, the investment increases in value when the market falls.

The leverage in Xact Bull and Bear ETFs is calculated on a daily basis.

It is a difference between daily leverage and leverage calculated for a longer period. Over an extended period of time, the return for Xact Bull and Xact Bear will not be the return for the entire period multiplied by the leverage factor, but the result of the daily changes during the period. 

Leveraged products offer an opportunity for higher returns, but also for higher risk. Leveraged products do not behave the same way as products without leverage and it is therefore important to understand how a leveraged product works. Xact’s leveraged ETFs are only suitable as an investment if you:

  • understand the characteristics of leveraged products
  • understand the effects of daily rebalancing, and
  • actively work with and continuously monitor your investment portfolio, since leverage causes the value to change faster than corresponding investments without leverage. 

This is how Bull works

Xact Bull increases in value when the market rises.

Xact has ETFs with leverage of 1.5 and 2 times the daily percentage change in the underlying market. It is important to remember that if the underlying market falls, the return on the ETF will also fall with this leverage factor.

You believe that the Swedish equity market will go up so you invest in Xact Bull 2​ which tracks the OMXS30™ index with daily double leverage. If the index rises by 2 per cent in one day, the value of Xact Bull 2 ​​rises by approximately 4 per cent. Conversely, if the index drops 2 per cent in one day the value of Xact Bull 2 drops by approximately 4 per cent on that same day. 

Exemple Bull

The table below shows the performance of Xact Bull 2 ​​compared with index over a period longer than one day. 

  Index Daily percentage change XACT Bull2  Daily percentage change  
Dag 1 100,0   100,0    
Dag 2 102,6 2,6% 105,2  5,2%  
Dag 3 105,0 2,3% 110,0  4,6%  
Dag 4 104,1 -0,8% 108,3  -1,6%  
Dag 5 107,9 3,6% 116,1  7,2%  
Dag 6 106,0 -1,7% 112,1  -3,4%  

In six days, the index rose by 6.0 per cent. During the same period Xact Bull 2 ​​has increased in value by 12.1 per cent, slightly more than twice the index performance for the period. The main reason is that the performance of the leveraged ETF is based on the daily index performance and not on the double performance over a longer period of time. Thus in the longer term, the performance of Xact Bull 2 ​​can be either greater or less than twice the index performance.

This is how Bear works

Xact Bear ETFs increases in value when the market falls.

Xact has ETFs with an inverse leverage of 1.5 and 2 times the daily percentage change in the underlying market. It is important to remember that if the underlying market rises, the return on the Bear ETF will fall with this leverage factor.

You believe that the OMXS30™ index will fall. You invest in Xact Bear 2, which gives you twice the upswing as the daily percentage decline in OMXS30™ index. If  index drops by 2 per cent in one day, Xact Bear 2 rises by approximately 4 per cent that day. And conversely, if the index rises by 2 per cent, the value of Xact Bear 2 drops by about 4 per cent on the same day. 

Example Bear

The table shows performance of Xact Bear 2 compared with the index for a period lomger than one day..

  Index Daily percentage change XACT Bear2  Daily percentage change  
Dag 1 100,0   100,0     
Dag 2 97,5 -2,5% 105,0  5,0%  
Dag 3 95,4 -2,2% 109,6  4,4%  
Dag 4 96,1 0,8% 107,9  -1,6%  
Dag 5 92,7 -3,6% 115,6  7,2%  
Dag 6 94,2 1,7% 111,7  -3,4%  

In six days, the index slipped 5.8 per cent. During the same period Xact Bear 2 increased in value with 11.7 per cent, somewhat more than twice the decline of the index. The main reason is that the performance of Xact Bear 2 is based on the daily index performance and not on the double performance over a longer period of time. Note that in the longer term, the positive performance of Xact Bear 2 can be both greater or less than twice the percentage decline of the index.

The value of Xact Bull and Xact Bear is dependent on daily changes in the market

The objective of Xact´s leveraged ETFs is to generate a return of approximately 150 or 200 per cent of the daily return of the underlying benchmark-index.

If you invest as much money in Xact Bull and Xact Bear and keep both investments for one day, they will become the mirror image of one another. However, if you keep them for a longer period, the picture will change.

Use the “Performance Calculator” under “Tools” for assumptions about the daily index performance and see how it affects the return on Xact’s leveraged ETFs over a longer period of time.

Value over a longer period of time

Xact’s Bull and Bear ETFs have a daily leverage of 150 or 200 per cent, which means that the change in value of the ETFs is greater than the change in the underlying market.

There is also a difference between leverage calculated on a daily basis and leverage calculated over a longer period of time. For a longer period, the return on Xact’s leveraged ETFs will be the result of the sum of daily changes during the period, not the return for the entire period multiplied by the leverage factor.

Example

Suppose that OMXS30™ rises by 5 per cent from 1 February to March 31. Will Xact Bull2 have increased in value by 10 per cent during the same period? The answer is no. The fund’s return for the period will be a result of the fund’s daily return. The return over a longer period will differ from the value obtained if you just multiply index performance by 2. In some cases, this comparison results in an advantage for the investor, sometimes a disadvantage.

Leveraged products perform best in a market with a clear trend

In a market with a clear trend, up or down, the leverage in Xact’s leveraged ETFs will have a positive impact on returns over periods longer than one day, because of the compound interest effect. The return over a longer period will thus be better than the index performance for the relevant period multiplied by the relevant leverage factor.

The market has a clear upward trend

In a market with a clear positive trend, both Bull and Bear will provide a better return than what we achieve if the index performance for the period is multiplied by the leverage factor.  

 

The example shows Xact Bull 2 

In the example, index increases 50 per cent. Xact Bull 2 ​​rises during the corresponding period from 100 to 269, an increase of 169 per cent. Daily leverage means that more and more capital is exposed to the market. We get a compound interest effect in the fund. This can be compared with only multiplying the index performance for the period by the fund’s leverage factor, resulting in an increase of 100 per cent (purple line).

The example shows Xact Bear 2 

Xact Bear 2 will also perform better than might have been expected in a steadily rising market. In the example Xact Bear drops in value from 100 to 36.4 (-63.6 per cent). This is less than the reduction in value of -100 per cent which we obtain if the index performance is multiplied by -2, which would also have meant liquidation of the fund on day 51 (purple line). Thus Xact Bear 2 will also benefit from the return calculated on a daily basis, since less and less capital is exposed to the market, as the market rises and Xact Bear2 falls in value.

When the market has a clear downward trend 

In a market with a clear downward trend Xact Bear will increase sharply in value. Xact Bull will fall in value, however more slowly than one might expect.

The example shows Xact Bear 2

In the example, index performance drops by 50 per cent. Xact Bear 2 rises in value during the corresponding period from 100 to 388.5, an increase of 288.5 per cent. Daily leverage means that more and more capital is exposed to the market. We get a compound interest effect in the fund. This can be compared with only multiplying the index performance for the period by the fund’s leverage factor, resulting in an increase of 100 per cent (purple line).

The example shows Xact Bull 2

Xact Bull 2 will also perform better than might have been expected in a steadily declining market. In the example Xact Bull 2 drops in value from 100 to 24.7 (-75.3%). This is less than the reduction in value of -100 per cent which we obtain if the index performance is multiplied by 2, which would also have meant liquidation of the fund on day 51. Xact Bull 2 ​​will benefit from calculating the return on a daily basis, since less and less capital is exposed to the market, as the market rises and Xact Bear drops in value. 

A volatile market with no clear trend harms leveraged products

In a volatile market, with no clear trend, the daily leverage will have a negative impact on the returns over a period longer than one day. If the index returns to its initial level, the leverage ETFs will yield different; Xact Bear2 will perform worse than Xact Bull2. For the index to regain its original value greater percentage gains than percentage declines are required. A simple example of this; if an asset falls in value by 50 percent, a rise of 100 percent is needed in order to regain its inital value.

Index returns to the same level

The examples show how index returns to its initial level at the end of the period since the percentage increase has been greater than the decline. But both Bull and Bear will have dropped in value. However, Xact Bear 2 has lost more in value than Xact Bull 2 because the upswing was larger than the decline. But why did Xact Bull 2 ​​also drop in value? Because when the stock market drops one day, Xact Bull 2, after rebalancing, will have less capital exposed to the stock market for the next day’s stock market rally.

Stock market volatility is symmetric

In a market where percentage gains are equal to percentage declines, both the index and Bull and Bear would fall in value. Even though the percentage gains are equal to the percentage declines, changes in the value up and down would not be equal.

The example assumes that over a ten-day period, the index rises on one day by 10 per cent, after which it drops on the next day by 10 per cent. At the end of the period, the index has fallen from 100 to 95.1 (-4.9 per cent). The explanation is the same as in the previous example: greater percentage increases than declines are needed for the value to return to its previous level. Xact Bull and Xact Bear have dropped in value by the same amount, -18.5 per cent, which is more than the index change multiplied by the leverage factor.

Xact Bull & Bear exposure is generated in the futures market

The investment strategy of the ETFs is to provide daily exposure of about 150 or 200 per cent of the daily performance of the OMXS30™ index. Since an index is not investable, Xact’s leveraged ETFs generate their exposure through equity index futures. 

Xact Bull, which has a positive exposure to stock market trends, invests in cash and buys (long position) OMXS30™ futures, corresponding to approximately 150 per cent (or 200 per cent for Xact Bull 2) of the fund’s value.

Xact Bear, which has a negative, or inverse, exposure to the stock market, invests in cash and sells (short position) OMXS30™ futures, corresponding to approximately 150 per cent (or 200 per cent for Xact Bear 2) of the fund’s value.

Daily rebalancing of futures holdings

If the stock market fluctuates during a trading day, the futures holdings have to be adjusted (rebalanced) through additional purchases or sales of futures contracts. This achieves an exposure that is always as close as possible to +/-150 (or 200) per cent of the value of the EFT before the next trading day begins. The investor’s risk and return potential are thus proportional to the current value of the fund units today, not to the initial investment. 

Xact Bull

Index increases by 2 percent

1. Initial investment and exposure

If a fund with + 150% leverage has an invested capital of 100, the fund invests in index futures for a value of 150.

2. Index rises by 2 percentage points

Index rises by 2 percentage points in one trading day. The value of futures holdings have increased to 153. An increase in value has occurred with 3 and fund assets are now 103.

3. Rebalancing of the Fund

The investment strategy is that the fund´s assets should have an exposure of about + 150% of the index in the beginning of each new trading. As fund assets have now increased in value to 103, the fund must increase its exposure through additional purchase of index futures worth 1.50 (103 x 150% = 154.50) to maintain the daily exposure of 150%.

Xact Bull

Index decreases by 2 percent

1. Initial investment and exposure

If a fund with + 150% leverage has an invested capital of 100, the fund invests in index futures for a value of 150.

2. Index declines by 2 percentage points

Index declines by 2 percentage points in one trading day. The value of futures holdings have decreased to 147. A decrease in value has occurred with 3 and fund assets are now 97.

3. Rebalancing of the Fund

The investment strategy is that the fund´s assets should have an exposure of about + 150% of the index in the beginning of each new trading. As fund assets have now decreased in value to 97, the fund must decrease its exposure through sale of index futures worth 1.50 (97 x 150% = 145,50) to maintain the daily exposure of 150%.

No rebalancing during the day

The funds adjust their exposure each day at closing, but not continuously throughout the day. If the stock market fluctuates significantly during the day, the exposure of the ETFs will be slightly too small in an upswing, and slightly too large in a decline. This effect impacts those who invest during the day, before the fund rebalances at closing.

 

 

Deviations in performance between Xact Bull and Bear and index

Sometimes the reported returns in Xact Bull and Bear differ from the reported performance of the index. Why is that? 

Different measurement periods for ETFs and index

Reported returns in Xact’s leveraged ETFs and reported performance of the OMXS30™ index are measured at different times. While the change in value of ETFs is measured at 5:25 pm, when the futures market and trading in ETFs close on one trading day until the same time on the next trading day, the change in the index is measured from 5:30 pm, when the stock exchange closes, until 5:30 pm the next day. This means that regardless of how much the index fluctuates during the last five minutes until 5:30 pm, when the index is measured, the returns for Xact Bull and Xact Bear will be measured according to their leverage factor from 5:25 pm on one day until 5:25 pm the next day.

Suppose that the OMXS30™ climbs 0.30 per cent between 5:25 pm and 5:30 pm. Also suppose that the index does not fluctuate at all the next day. Xact Bull 2 ​​will show an upswing of about + 0.60 per cent and Xact Bear 2 a decline of about -0.60 per cent, even though the market did not fluctuate on this day. In this case, the change in value of the ETFs is solely due to the different measurement times for the funds and the index.

Time of last trade

If the last trade in the ETFs is executed a short time before closing at 5:25 pm, the measurement period will be further displaced. 

Divergence between index and futures

Xact Bull and Xact Bear invest in OMXS30™ index futures and not directly in the OMXS30™ index. Small differences in yields may arise because of the internal relationship between the future and the index. If the futures price substantially deviates from the index, an arbitrage opportunity will arise. Usually the effect is small.

About the OMXS30™ index during dividend season and how this affects Xact Bull and Xact Bear

Many of the indexes shown are price indexes. This type of index does not take dividends paid into account. Consequently when a company included in the index pays dividends, a price index will fall, despite the fact that an investor as owner of an index portfolio has received dividends equal to the reduced value of the index.

Example of how dividends affect a portfolio 

  • A person owns a basket with all the equities included in the OMXS30™ index. The basket is worth SEK 100. During the day the stock exchange stands completely still. The only thing that happens is that companies in the equity basket pay a dividend of SEK 1. The owner of the index basket therefore has no change in assets.

Morning portfolio: SEK 100 in the index portfolio  

Evening portfolio: SEK 99 in the index portfolio and SEK 1 in cash

Total value of the portfolio is unchanged: SEK 99 + SEK 1 = SEK 100

Xact’s leveraged ETFs should be viewed as “portfolios”, as though the investor owned an equity portfolio. In an equity portfolio, the assets do not change when dividends are paid. The equity drops, assuming all other factors are equal, with the size of the dividend and the dividend is paid into a yield account. The portfolio (equity + cash dividend) is worth the same amount both before and after the dividend.

When comparing the performance of Xact Bull and Xact Bear with the OMXS30™ price index, it will look as though Xact Bull and Xact Bear did not follow the index. But this is only a mathematical effect of how a price index is calculated; it ignores the dividends paid. Unit-holders do not experience any wealth effect when the price index falls because of dividends paid; Xact Bear does not increase in value and Xact Bull does not fall in value. 

OMXS30™ price index: -1%

Bull: + 0%
Bear:+ 0%

To measure how Xact Bull and Xact Bear perform compared to index, the funds are compared with the OMXS30™ GI (Gross Index), i.e the benchmark index for the fund. This index takes into account dividends paid, and therefore does not drop on ex.date for dividends. The performance of this index, is displayed on the NASDAQ OMX Stockholm website .

Divergence between futures price and price index

OMXS30™ futures track the OMXS30™ price index since the futures do not receive dividends from companies included in the index, nor do they pay dividends to the holder. The buyer of a futures contract knows this and therefore is not prepared to pay “full price” for the futures contract. If the value is SEK 100, but SEK 2 will be paid in dividend (which the futures holder will not receive), the buyer is therefore only willing to pay SEK 98 for the future. This means that the futures price is adjusted for all future dividends under the relevant contract. This can be compared with the OMXS30™ price index, which falls on the day when the dividend from the included companies is separated. As a result, futures can deviate from the index.

When the future is rolled into the next contract, the value of Xact Bull and Bear would fall, all else being equal, if the new contract has another lower price because of the discounted dividends. The effect would be that Bear would seem to have risen in value and Bull have fallen.

Since the funds can be compared with “portfolios” in terms of assets, which means they will not be affected when dividends fall or if they are going to fall, the fund’s futures holdings must be rebalanced. The manager adjusts the portfolio by buying or selling more futures equivalent to the “discount” (which corresponds with future dividends) in the futures price. Additional purchases or sales enable the fund to recover the reduced value, which can be compared with “adding back in” future dividends.

To measure how Xact Bull and Xact Bear perform compared to index, the funds are compared with the OMXS30™ GI (Gross Index), i.e the benchmark index for the fund. 

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  • i Source: Millistream
  • Updated Updated 06:19, 2020-11-25
  • i Source: Handelsbanken
  • Uppdated Uppdated 06:19, 2020-11-25
  • Information Source: Handelsbanken
  • Updated Updated 06:19, 2020-11-25

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Data source

This information is updated every 15th minute from Millistream. Xact does not assume any liability for errors in the information.

Data source

This information is updated every 15th minute from Handelsbanken. Xact does not assume any liability for errors in the information.