What is the TQQQ?
History of the TQQQ ETF
TQQQ is a 3x levered fund that seeks to magnify the daily movement of the QQQ (a fund that mirrors the Nasdaq 100).
It was only a matter of time until leverage was introduced into the ecosystem of ETF funds. The ProShares UltraPro QQQ ETF (NASDAQ:TQQQ), a levered ETF aims to deliver 3x the daily returns of the wider Nasdaq index (QQQ).
In this article we'll assess the particular risks that come with investments in this type of vehicle, what kind of investor may find it appealing, and what the potential outlook is for the index.
Leverage and the TQQQ
Leverage in ETFs can be achieved in many ways, and it is no simple task to attempt to replicate 3x the daily result--up or down--of any index. To do this, TQQQ uses two principal derivatives instruments in addition to pure equity positions, swaps and futures.
Swaps are agreements between two parties to pay one or the other the difference between the price of an asset today and the price of the asset in the future. As a structured trade, these transactions can be as simple or complicated as the parties wish, and the parameters are, again, defined wholly by the two parties. Futures are levered instruments in and of themselves, where one makes an agreement with another party in a standardized market.
Using both of these gives TQQQ a lot of leeway--it allows the fund to move between markets with standardized risk parameters and markets where it can manage its own risk. The principle risk, in our view, to this scheme is counterparty risk. This is the risk that one of TQQQ's swap partners (or TQQQ itself) will be unable to make good on its part of the swap deal in the event of an unforeseen market event.
While this might sound remote, especially among institutional investors, it is a very real risk, especially when you consider that swaps are structured by the parties themselves and introduce as much leverage as the parties are willing to allow. In the end, however, the result is that TQQQ moves roughly 3x the daily movement of QQQ.
Those newer to the world of levered ETFs may find this incredibly compelling for a long-term investment--after all, conventional wisdom says that market bias is up and to the right. Why not buy and hold something like TQQQ for 3x the long term gains?
The problem is the levered instruments in the fund don't work that way. The emphasis on the daily nature of the fund is emphasized in the top block of the fund's fact sheet:
ProShares UltraPro QQQ seeks a return that is 3x the return of its index (target) for a single day, as measured from one NAV calculation to the next. Due to the compounding of daily returns, holding periods of greater than one day can result in returns that are significantly different than the target return and ProShares' returns over periods other than one day will likely differ in amount and possibly direction from the target return for the same period. These effects may be more pronounced in funds with larger or inverse multiples and in funds with volatile benchmarks. Investors should monitor their holdings as frequently as daily. Investors should consult the prospectus for further details on the calculation of the returns and the risks associated with investing in this product.
Additionally, investors must also know that the fund (being based on the returns of QQQ) is incredibly tech-heavy. With a little more than 50% of the fund's assets invested in the technology sector, and over 40% of the fund concentrated in Microsoft, Apple, NVIDIA, Amazon, Tesla, and Meta Platforms, investors need to know that buying into TQQQ is, in some ways, a wager on the daily moves of these particular companies.
Investing in the TQQQ: Big Gains, Big Risks
TQQQ's summary prospectus pulls no punches in addressing the particular risks associated with investing in the fund. In the summary prospectus, the first risk listed reads "You may lose the full value of your investment in one day."
We want to hammer home the potential risk of losing your entire investment in not one month, not one year, but one day. This is, in plain language, the risk investors face when dealing in swaps, futures, and other derivatives underlying the equity investment.
TQQQ: The Bottom Line
For investors seeking magnified exposure to the QQQ index over very short time periods, TQQQ may present a compelling investment. Those looking for returns over a longer period should probably look elsewhere, given the magnified nature of returns, as well as the short-term duration of the underlying derivatives.
Traders may decide that TQQQ is best used tactically, as a way execute an event driven strategy or for those who want to utilize leverage, but we hope we have made a case here that the risks associated with TQQQ and other levered funds should be approached clear-eyed.
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