The race to launch ever-riskier leveraged ETFs -2-

"If somebody launched a 5x Nvidia product tomorrow, it would probably get half a million dollars overnight. The appetite for degenerate leverage is pretty strong right now," Nadig told MarketWatch.

See: Is investing becoming more like gambling? Yes or no? Betting on the new trading craze.

If the SEC doesn't explicitly reject the filings by late December, the firms would have the option to launch these products.

While some of these leveraged funds have seen significant demand, whether investors understand how they work is less clear. Because the leverage only applies to daily moves, returns on these products are subject to a large compounding effect. This means daily losses have an outsize impact on returns over time. Investors who purchased these products expecting them to deliver 2x or 3x the return of a given stock or index over time have often been disappointed.

As an example, Rob Haugen, chief investment officer at River1 Asset Management, said he ran the numbers and found that shares of Nvidia had handily outperformed a 2x leveraged Nvidia fund over the past year.

FactSet data bears this out: Nvidia was up 29.3% over the past year, while the GraniteShares 2x Long NVDA Daily ETF NVDL was about 14.9% higher as of early trading on Thursday. A similar pattern has played out for leveraged funds targeting Tesla Inc. (TSLA) and other hot stocks.

Furthermore, leveraged funds typically charge much higher fees than a typical index fund. Fees on some are as high as 1% annually. Also, some of the returns for these products are eaten away by what Haugen calls hidden costs - including the fees that investment banks charge for supplying the swaps that many of these funds rely on to achieve their targeted daily return.

"The winner in that case is the person or organization who is making markets in those swaps, not the investor," Haugen said. Haugen's firm manages the Trenchless Fund ETF RVER, an actively managed ETF that aims to outperform the S&P 500.

Leveraged funds can also help investors manage their risk by allowing them to cheaply hedge their exposure to a single stock or the broader market, Indxx's Sen Sharma said.

-Joseph Adinolfi

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