Leveraged Funds - Benefits, Types, Risks & Drawbacks

Investors are constantly playing their cards to bring out the maximum returns from their investment. Leveraged funds are one such way to knock the stock market’s overall performance. These funds hold both debt and shareholder equity and use the debt to optimise the returns.

Read further to know more about this ETF in detail.

What Are Leveraged Funds?

These are mutual funds that utilise financial leveraged investment techniques to maximise returns. These techniques include trading, buying assets on margin, short selling, etc. Leveraged ETFs provide a multiple of the index or benchmark that they track.

These ETFs typically utilise derivatives like options, futures and swaps to amplify the performance. Below is a brief discussion of how they work.

How Do Leveraged Funds Work?

Leveraged funds function through standard brokerage accounts, using margin. Investors borrow money from brokerages to purchase stocks intending higher gains. In simple words, you buy a larger portion in much smaller capital.

For instance, you buy mutual funds worth ₹ 60,000 and borrow ₹ 60,000 for additional investments. Thus, returns will be relatively higher than the initial investment with an increase in the mutual fund’s value.

However, this brings a risk of experiencing significantly higher loss in case of a dip in the mutual fund’s value. Therefore, the investment will depend totally upon the investor’s risk appetite. Also, the cost of operating leveraged mutual funds is much higher than other funds. The expense ratio may range between 3% and 5% a year.

What Are the Benefits of Leveraged Funds?

Here are some benefits of these exchange-traded funds -

1. Ease of Tracking the Index

These funds track the underlying index thoroughly, which eases your investment strategies. This is better than relying on the data of a certain type of mutual fund. These funds also ensure lower exposure to risk and excellent investment performance.

2. High Returns Regardless of Investment

Leveraged funds ensure high returns to all the investors regardless of their investment. Investors who opt for a shorter tenure gain similar returns than those who invest for longer.

3. Absence of Per-Trade Transaction Expense

These types of mutual funds come with the benefit of not having per-trade transaction costs. This encourages the investors towards short-term swing trades.

4. Cost-Effectiveness

With the advantage of not having per-trade transaction costs, these also have no performance fees. Therefore, you can invest small instead of a lump sum according to your financial convenience over a course of time.

5. Diversification

A diversified portfolio is somewhat challenging with small investments in the capital market. But fortunately, these ETFs allow attaining a diversified portfolio that ensures optimum returns and low risk.

What Are the Different Types of Leveraged Funds?

The following table shows all the types of leveraged funds.

Types	Explainations
Money Market Funds	Such ETFs invest in government bonds such as treasury bills (short-term)
Bond Funds	These funds invest in fixed-income assets such as bonds, debentures, treasury bills, and mortgages.
Equity Funds	Mutual funds that invest in the stock market, covering top categories like healthcare, IT and telecommunication, industrials, financials, etc.
Index Funds	These ETFs invest in assets that generate fixed income and follow a specific index like NIFTY 50, SENSEX, etc.
Balanced Funds	Such leveraged ETFs invest in a combination of bonds and stocks where holdings are balanced between debt and equity.
Specialty Funds	Funds like these invest only in distinct assets such as real estate, currencies, funds of funds, etc.

What Are the Risks and Drawbacks of Leveraged Funds?

Some cons of leveraged funds are stated below -

These funds do not exactly reflect the daily returns of the index they follow in the long run.
The expanded daily returns may provoke abrupt losses in the short term. It may also result in a loss of the funds’ value.
Certain leveraged ETFs are not likely to trade copiously, which restricts your capacity to sell or buy.
As they use derivatives to amplify returns, these funds do not track the underlying benchmark carefully.

Investors must keep in mind their tolerance of risk before opting for investing in leveraged funds. Additionally, they must consider the higher expense ratio, their investment horizon and other factors that may influence their investment strategy. Lastly, it is crucial to acquire proper market experience before investing in such ETFs.

Frequently Asked Questions

✓ What are leveraged 2X funds?

Leveraged 2X funds utilise leverage to double the daily return of the underlying index or benchmark. These funds track a wide range of asset categories, like bonds, stocks or commodity futures.

✓ How does a leveraged ETF perform in the long run?

Leverage funds boost the performance of indexes but fail to do so in the long run. These funds mirror the daily returns of an underlying index and optimise that. Therefore, the returns start getting crooked over a longer course of time.

✓ Can leveraged 3X funds be safe?

Triple-leveraged mutual funds are subject to considerable risk for long-term investments. These are not appropriate for investors but traders who exchange these funds within a short span.