Few funds in history can rival the returns of ProShares UltraPro QQQ, a $7 billion exchange-traded fund that seeks to triple the daily performance of the Nasdaq 100 index.
Yet fewer can rival its risk, and you can lose money on it even in a flat or rising market. You should think three times before investing in such a fund.
Commonly called by its ticker symbol, TQQQ, the fund returned an average of 51.5% annually over the 10 years ended July 31, making it the single best-performing mutual fund or ETF of the past decade, according to Morningstar Inc. Over the 10 years through Aug. 13, the fund has earned a cumulative gain of 7,298%.
TQQQ fired up the returns of the already smoking-hot Nasdaq 100 index, dominated by such market darlings as Apple Inc., Microsoft Corp. and Amazon.com Inc.
So far this year, the Nasdaq 100 is up “only” 28.7%. The TQQQ fund leveraged, or amplified, that into a 47.6% gain largely by using instruments known as total-return swaps to triple the daily return of the index.
Like other leveraged funds, TQQQ has done a good job of achieving its daily goal. But, as I’ve warned over the years, almost anything can happen when you own such a fund for longer than one day.
Between Feb. 18 and March 20, during the coronavirus crash, the Nasdaq 100 fell 27.3%. TQQQ lost 69.1%.
If you’d bought TQQQ three years ago, you would have more than tripled your money by this week—but only if you somehow managed to hang on the whole time. Twice along the way, in December 2018 and again this March, more than 100% of your cumulative gains would have been wiped out, according to FactSet.
To see how this can happen, let’s say you put $10,000 in the Nasdaq 100 index and another $10,000 in TQQQ.
On day one, the Nasdaq 100 goes up 2%, turning that $10,000 into $10,200. TQQQ, tripling the daily return of the index, goes up 6%, turning your other $10,000 into $10,600.
On day two, the index falls back 1.96%, leaving you the $10,000 you started with. The leveraged fund, however, triples the market’s losses as well as its gains. So TQQQ falls three times as much, shrinking to $9,976.
If the same thing happens two more days in a row, you’ll finish with $10,000 in the Nasdaq 100, but TQQQ will have shrunk to $9,953. With the triple fund, you’ll have lost 0.5% in four days—even though the market ended right where it began. (That’s not counting the fund’s 0.95% in annual expenses.)
Let me put all those numbers into plain English: Even a flat market—which, with inflation low, leaves other investors no worse off than they started—can eventually deal devastating losses to people who hold leveraged ETFs.
And a rising Nasdaq, if it goes up in a jagged line rather than the predominantly smooth path it took over the past decade, can still inflict losses on a leveraged ETF.
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According to an analysis that ProShares provided upon my request, TQQQ could lose an estimated 0.7% to 95% over the course of a year when the Nasdaq 100 breaks even, depending on how much the index bounces up and down along the way.
If the index’s annualized standard deviation, a statistical measure of how much a market fluctuates, is 30%, the fund would lose 23.7% when the Nasdaq 100 goes nowhere, estimates ProShares.
In short, if you hold this fund over the course of a year when the Nasdaq 100 is flat, you are highly likely to lose money—potentially nearly all your money.
Even at a moderate, and historically normal, 20% volatility, the fund would lose 11% in a flat market over the course of a year, estimates ProShares.
Does everyone understand that?
ProShares believes the fund is used primarily by financial advisers and professional investors, says the firm’s co-founder and chief executive, Michael Sapir.
“We don’t promote long-term use of these products,” he says, “and the vast majority of investors don’t use them in that fashion.”
And TQQQ’s prospectus warns candidly that it “will lose money if the [Nasdaq] index’s performance is flat over time,” adding that “the fund can lose money regardless of the performance of the index.”
Still, it isn’t clear that all the buyers of the fund fully understand how it works.
“You have a flock of new investors that may not be doing the proper due diligence necessary for these types of investments,” says Matthew Crouse, a visiting finance professor at Westminster College in Salt Lake City who wrote a recent article about the potential for losses at such funds. “The track records are so tremendous that you can get trapped into looking at the returns without fully considering the risks.”
The brokerage app Robinhood caters to inexperienced individual traders. The number of its users owning TQQQ rose from about 10,000 in January to nearly 26,000 by late July, according to Robintrack, an independent website that has been monitoring how many Robinhood accounts hold particular stocks.
Should Nasdaq stop rising, some of these TQQQ buyers could be in for a hard landing.
“If you don’t understand the investment, don’t buy it,” warns Mr. Sapir. “We don’t want anyone to have an experience of getting a return that is unexpected.”
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