Source: Deutsche Bank

It seems that investors have preferred the long ETFs to the inverse versions for most of the last year, with the ratio substantially in favour of the longs for the EURO STOXX 50 funds. Manooj Mistry of db x-trackers pointed out to me that the inverse ETFs have tended to be used by European investors as a short-term tactical trading vehicle, whereas the long versions have had more stable holders, so making a direct comparison between the respective funds' sizes may not mean much.

However, if we look at leveraged long and short funds in Europe, taking, for example, the XACT bull and bear ETFs (Stockholm:XACT-BULL.ST, XACT-BEAR.ST)—with 150% and -150% leverage respectively—or the SGAM leveraged CAC 40 and XBear CAC 40 ETFs (Paris:L40.PA, BX4.PA)—with leverage of 200% and -200%—then in each case, the inverse versions currently have larger AUM than the long versions, according to the latest Deutsche Bank figures.* This, incidentally, ties in with current U.S. market experience for a number of leveraged and double-inverse fund pairs. While some analysts have used these AUM ratios as (contrarian) market sentiment indicators, at the very least, the size of the leveraged inverse ETFs shows how popular short-selling has become. Don't tell the SEC or the FSA!

What is next on the product development front in Europe? Bearing in mind that fund providers will wish to continue to apply the UCITS stamp to their ETFs, and that the UCITS rules allow leverage of up to 200% of NAV, there is clearly scope for further leveraged (and leveraged-short) ETFs to be launched.

Possible Downsides 

At the same time, there is growing awareness of the potential drawbacks of funds operating with constant leverage ratios, notably the tendency to drift from the target over longer holding periods, a phenomenon that was highlighted by Tristan Yates and Lye Kok of Index Roll last year and has been reiterated in a recent research paper by Trainor and Baryla for the Journal of Financial Planning.

SGAM's Francois Millet pointed out that European ETF product developers have been looking at ways of getting round the constant leverage problem, perhaps by launching fixed-maturity ETFs that could trade like futures.

There is an obvious gap to fill in equity sector long/short ETFs, an area which has been very popular in the U.S. but remains relatively underdeveloped in Europe, with only db x-trackers offering funds of this type.

And there are plenty of underlying asset classes that are still to be covered by inverse and leveraged ETFs. The commodities space already sees ETF Securities offering a wide range of products, but there are plenty of possibilities in fixed income, for example.

So, in summary, while the leveraged and inverse ETF sector in Europe has developed less quickly than in the U.S., it is still an area of dynamic product development and increasing investor demand. We can expect more firms to become involved and further innovation from the main ETF market players.

Paul Amery is the European correspondent for IndexUniverse.com. He can be reached at This e-mail address is being protected from spambots. You need JavaScript enabled to view it .

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