January 30, 2020
I am an ordinary investor that does not fully understand all the mechanisms by which the leveraged funds I own achieve the leverage targets they deliver. I still, however, know enough to effectively use them.
Leveraged funds (particulary 2x and 3x bull indices funds of which I greatly enjoy owning and monitoring) provide superior performance over the long term with minimized risk as compared to providing my own 2x or 3x leverage in borrowing the equivalent money to invest in a standard index fund. I know they are risky, it is leverage afterall, but this fund can only go as low as zero. By providing my own leverage I could lose 200% or 300% of my investment plus the interest on my loans. These funds allow me to participate in a leveraged upside while limited my downside to 100% regardless of the "black box" by which they deliver the leverage.
Regarding the elitist view that one must fully understand the mechanism behind an investment in order to be allowed to participate, I ask the following questions.
Do you understand all the mechanisms by which your laundry machine washes your closthes? You are after all risking your material possessions every time you place them in to the machine and hit start
Do you understand all the mechanisms by which your car provides propulsion in direction you want to go? You are after all risking your life in entering a confined space in proximity to a miniature explosion chamber merely for the purpose of less burdensome transportation- how wreckless
Do you understand all the mechanisms by which stearic acid salts remove body oils? You presumably still rub those chemicals all over your body in the shower every morning.
The mechanism of these things is only mildly important to the consumer. What matters is the performance to the stated objectives. Nobody is under the illusion that a fund that is stated as 3x leveraged will lose approximately 3 times as a percent as the underlying index. I am aware that if the index loses greater than 33% in a day that my entire investment could be gone in that one day. But the math required to understand this is merely multiplication and addition. Anyone with a grade school education should get. A mechanistic understanding of the funds leverage "black box" is not necessary. Comparison of the leveraged funds historical performance compared to the index it tracks and checking
I am not, however against some legislative oversight of these funds, but blocking access to high growth potential funds to only fellow elite investors only serves to further widen the wealth gap. An action that would actually be equitable and useful is to set performance goals for the black box on how they achieve their leverage and possibly even create and/or mandate insurance for the downside proportional to the funds stated goals.
For example- if the underlying index declines 20% and the 3X leveraged bull fund declines 65% then the insurance would cover the 5% that extends beyond the indexes stated relationship to the underlying index. This would be a true consumer protection as it protects against failures of the companys mechanism in the fund from underperforming the stated relationship the fund is supposed to deliver.
In summary, leverage is incredibly easy to understand but the mechanism of how the fund achieves it is not. If the SEC follows the elitist line of further restricting the best investment vehicles to those who can understand the black box of the fund they are working against the people they claim to protect. Proper consumer protections could be put in place, however, to protect the average consumer from failures of the black box that deliver worse than advertised results do deserve to have additional protections put in place.
Thanks for listening to my thoughts