Composition and Exposure of leveraged and inverse ETFs

Leveraged and inverse ETFs are powerful investment vehicles for investors seeking to gain magnified exposure to the markets. They seek to keep a constant leverage ratio on a daily basis, which can vary up and down between 2:1 or 2X (to double the return) and 3:1 or 3X (to triple the return). With inverse ETFs, the funds seek to return the inverse of their stated leverage ratio (between -3X and -1X), also on a daily basis.

• To obtain the necessary exposure, the funds will invest in some combination of equity baskets and derivatives - typically swaps or futures contracts. These derivatives are agreements that provide the ability to gain exposure to specific indexes and sectors without the need for full dollar-for-dollar investment.

• The Bull ETFs generate a portion of their requisite exposure from equities and the remainder from derivatives.

• The Bear ETFs generate their entire short exposure through derivatives.

The actual holdings in the leveraged and leveraged inverse ETFs are quite different than the holdings of non-leveraged ETFs that typically hold a basket of securities. The following tables provide a perspective on the typical holdings within various types of leveraged and leveraged inverse ETFs.

Definitions

• Swaps - A derivative in which two counterparties agree to exchange one stream of cash flows for another stream. These streams are called the legs of the swap. The cash flows are calculated over a notional principal amount, which is usually not exchanged between counterparties. Consequently, swaps can be used to create unfunded exposures to an underlying asset since counterparties can earn the profit or loss from movements in price without having to post the notional amount in cash or collateral. Leveraged ETFs use a particular type of swap, a Total Return Swap, to obtain additional exposure or inverse exposure to the benchmark indexes that the funds track.

• Futures Contract - A contract, traded on a futures exchange, to buy or sell a standardized quantity of a specified commodity of standardized quality (e.g., a "basket" of corporate equities ["stock indices"]) at a certain date in the future, at a price (the futures price) determined by the market price at the time of the purchase or sale of the contract.

• Short Selling - The sale of a security that an investor borrows. The investor later closes out the position by returning the borrowed security to the securities lender, typically by purchasing securities on the open market.