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The stock market across the globe wrapped up the third quarter on a weak note. The MSCI's broadest index logged in the first quarter of losses since the COVID-19 outbreak early last year.

China’s stocks saw one of the heaviest drops ever, energy prices skyrocketed, inflation spiked and the central banks signaled tightening of policies. The combination of these factors took a toll on investors’ sentiment, leading to a large sell-off in September. Worries over the debt limit in Washington, the Chinese regulatory crackdown as well as concerns over the financial contagion due to the potential failure of China’s Evergrande property group added to the chaos.

The Dow Jones and the tech-heavy Nasdaq Index dropped 1.9% and 0.4%, respectively. The S&P 500 added just a modest 0.2% in the third quarter, representing the smallest quarterly gain since the pandemic first stunned the economy and financial markets.

The biggest vaccination drive, an expanded stimulus and the resumption of corporate earnings growth have been major catalysts in driving the market higher throughout the quarter. The recovering job market as well as reopening economies and businesses added to the strength. The combination of all the factors led to a pent-up demand, resulting in higher demand for all types of products and services in the economy.

The volatility has resulted in higher demand for leveraged and inverse-leveraged ETFs as these could fetch outsized returns on quick market turns in a short span. These products either create a leveraged long/short position, an inverse long/short position or a leveraged inverse long/short position in the underlying index through the use of swaps, options, future contracts, and other financial instruments.

Due to their compounding effect, investors can enjoy higher returns in a very short period provided the trend remains a friend. However, these funds run the risk of huge losses compared to traditional funds in fluctuating or seesawing markets. Further, their performance could vary significantly from the actual performance of their underlying index over a longer period when compared to a shorter period (such as weeks or months).

We have highlighted some leveraged/inverse products that gained more than 20% last quarter though these involve a great deal of risk when compared with the traditional products. This trend might continue at least for the near term if the sentiments remain the same.

MicroSectors Gold Miners -3X Inverse Leveraged ETN (GDXD - Free Report) – Up 47%

GDXD seeks to offer three times inverse leveraged exposure to the S-Network MicroSectors Gold Miners Index. The ETN has accumulated $29.1 million in its asset base and trades in an average daily volume of 50,000 shares. It charges 95 bps in annual fees.

ETFMG Prime 2x Daily Inverse Junior Silver Miners ETF (SINV - Free Report) – Up 44.2%

This ETF creates two times inverse exposure to the Prime Junior Silver Miners and Explorers Index, which offers exposure to the silver mining exploration and production industry. It charges investors an annual fee of 95 bps and has accumulated $0.9 million in its asset base since its debut in June. Volume is meager as it exchanges less than 500 shares in hand per day on average.

Direxion Daily FTSE China Bear 3x Shares (YANG - Free Report) – Up 43.3%

This fund targets the Chinese stock market and provides three times the inverse return of the FTSE China 50 Index. It has amassed $73.3 million in its asset base and sees a good trading volume of 1.1 million shares a day on average. Expense ratio comes in at 0.95%.

ProShares UltraShort MSCI Brazil Capped ETF (BZQ - Free Report) – Up 35.9%

This fund seeks to deliver twice the inverse performance of the MSCI Brazil 25/50 Index. The benchmark is a market capitalization-weighted index designed to measure the equity market performance of the Brazilian market. The product has amassed $17.8 million in its asset base while charging 95 bps in fees and expenses. It trades in good volume of about 378,000 shares a day.

Direxion Daily Emerging Markets Bear 3X Shares (EDZ - Free Report) – Up 22.6%

This ETF offers three times inverse exposure to the MSCI Emerging Markets Index. It charges investors 95 bps in annual fees and has amassed about $30.9 million in its asset base. The fund trades in good volumes of 333,000 shares a day on average.

Direxion Daily MSCI India Bull 2X Shares (INDL - Free Report) – Up 21.4%

INDL seeks to deliver twice the daily performance of the MSCI India Index, charging investors 95 bps in annual fees. The product has AUM of $121.7 million and trades in a moderate volume of about 35,000 shares per day.

Bottom Line

While this strategy is highly beneficial for short-term traders, it could lead to huge losses compared to the traditional funds in fluctuating or seesawing markets. Further, the funds’ performance could vary significantly from the actual performance of their underlying index over a longer period when compared to the shorter period (such as weeks or months) due to their compounding effect.