Since August, stock market volatility as measured by the VIX has maintained its highest average since 2009. At the same time, the number of leveraged and inverse ETFs has exploded to 249 products.
There are good reasons to suspect that the rise in volatility might be related to these types of ETFs. First of all, leveraged ETFs use derivatives, those notorious weapons of financial destruction. Secondly, they are much more volatile than the underlying indexes that they seek to track. Both leveraged long and short ETFs need to rebalance their portfolios daily by trading in the same direction as the market, potentially exacerbating market movements. Additionally, many investors were caught off guard by the impact of the daily reset on compound returns. Although it is difficult to disprove, we can point to several factors that suggest leveraged and inverse ETFs are not to blame and can offer a few plausible explanations for the increase in volatility based on economic fundamentals.
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Michael Rawson does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.