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Leverage on Germany pays off in 2012

German equity leveraged ETFs topped ETF performance in 2012, but these are a high-risk strategy only suitable for short-term traders.
January 11, 2013

The top-performing exchange traded funds (ETFs) of 2012 were dominated by funds with exposure to Germany and Turkey. Funds that track the DAX - the blue-chip stock market index consisting of the 30 major German companies trading on the Frankfurt Stock Exchange - led the way, with db x-trackers LevDAX Daily ETF 1C (XLDX), RBS Market Access LevDAX X2 Mthly Idx ETF (RDEL) and ETFX DAX 2x Long Fund (DL2P) posting returns of 58.19 per cent, 56.58 per cent and 53.9 per cent, respectively.

However, these are not a straight play on the DAX: these funds magnify the returns of the index they track. This is great in rising markets, as evidenced by the success of these ETFs in 2012, but when markets are falling you will get double the losses, so they are a very high-risk option. They rely on you timing the market precisely, which is next to impossible to achieve consistently. It is also not compatible with a long-term buy and hold investment strategy, because if you hold it for a long time sooner or later you will start to compound massive losses. Even if the index goes back to where it started when you bought the ETF, you will still have a paper loss.

Read more on the dangers of leveraged ETFs

For this reason you should only consider these if you are a day trader. If you want leverage, Christopher Aldous, chief executive of wealth manager Evercore Pan Asset, suggests contracts for difference (CFDs) on a trading platform, where you can get bigger exposure, or structured products.

If you are interested in exposure to German equities, which even without magnification made good returns over 2012, you could try Amundi ETF MSCI Germany (CG1), or a Europe ex UK ETF such as iShares MSCI Europe ex-UK (IEUX) of which Germany accounts for a large chunk - around a fifth.

In terms of active funds, Baring German Growth Trust (GB0000822576) favours small and mid-cap stocks, areas of the market not covered by London-listed ETFs and where analyst coverage is not always readily available (read our interview with Baring German Growth Trust manager Rob Smith).

Meanwhile, the Turkish stock market had an excellent year, boosting the returns on both Turkey-focused funds and ETFs. HSBC MSCI Turkey (HTRY) and iShares MSCI Turkey (ITKY) returned 52.31 per cent 51.15 per cent, respectively, in 2012. However, analysts and managers caution leaping into Turkey on the back of this performance, on the basis that past performance is no guarantee of future results.

"Turkey's clearly had a phenomenal performance," says Sonal Tanna, manager of JPMorgan Turkey Equity fund. "It would be unrealistic to expect the same kind of performance in 2013 that we saw in 2012, but we see absolute upside over the long term in Turkey."

Domestic growth and further monetary easing are two factors that will help support future growth in Turkey. Ms Tanna also notes that the country has a skilled, young labour force, which will help power the country's economy.

"The investment case for Turkey rests on favourable demographics, geographic position and macroeconomic normalisation," she adds. "In terms of promising sectors, we are currently finding the most compelling investment ideas in industrial and real estate companies."

Read more on investing in Turkey

Meanwhile, Alanna Petroff, of fund research company Morningstar, warns that investors should tread carefully, particularly before jumping into an investment that ties its fortunes to an individual country or sector. Conventional wisdom indicates that a well-diversified portfolio will be better equipped to navigate the ebbs and flows of varying market situations.

If you do opt for a single-country fund, advisers typically suggest that you should have a high risk appetite, a long time horizon and a large portfolio (£100,000 plus), and this type of fund should account at most for about 1-2 per cent of it. Both HSBC MSCI Turkey and iShares MSCI Turkey have tracked their index well, but HSBC has a lower charge of 0.6 per cent, against 0.74 per cent for iShares. However, iShares is a much larger fund (HSBC only has assets of around $6.5m), so is likely to be more liquid.

Both funds use physical replication - ie they buy the shares they track.

 

Top-performing London-listed ETFs in 2012

Fund

Return (Cumulative)

Fund Size (£m)

Total expense ratio (%)

Replication Method

db x-trackers LevDAX Daily ETF 1C

58.19

29.05

0.35

Synthetic Replication

RBS Market Access LevDAX X2 Mthly IdxETF

56.58

1.29

0.35

Synthetic Replication

ETFX DAX 2x Long Fund

53.90

24.23

0.40

Synthetic Replication

HSBC MSCI Turkey ETF

52.31

3.97

0.6

Physical-Full

iShares MSCI Turkey (IE)

51.15

174.10

0.74

Physical-Full

ETFS 3x Short JPY Long GBP

46.04

0.69

0.98

Synthetic Replication

ETFS Short Coffee ETC

44.19

1.50

0.98

Synthetic Replication

ETFS Leveraged Gasoline ETC

37.97

1.82

0.98

Synthetic Replication

Amundi ETF MSCI Europe Insurance

37.57

18.11

0.25

Synthetic Replication

db x-trackers MSCI Philippines IM ETF 1C

37.29

24.37

0.65

Synthetic Replication

Source: Morningstar