Leveraged ETFs don't suffer from leverage

I took an interest in mechanics of leveraged ETFs when I knew about two new products by direxion with exposition in RSX. I faced a huge number of critics on such investment products, also lot of critics on these critics. Even I found some strategies based on myths and misunderstanding these and similar financial instruments. I cannot say that leveraged products are better than investment without leverage exactly. As I can't conclude that leveraged products are better or worse leveraged exposition on underlying benchmark. It depend from investment policy of everyone, everyone's preferences which are different, as it well known.

Anyway usually conclusions are based on insufficient data. This can explain why some myths are so popular and why there are to many misunderstandings. I point on effect of leverage. When we judge some investment product we compare it with related benchmark. Usually we either watch changes in final worth or study compound rate of return. At the practice (and at theory too) leveraged scheme can not beat its own unleveraged underlying very often. But it does not mean that future value of worth (expected value) suffer from leverage definitely.

Russian Top Stocks (Valuation Measures & Dividend yield)

NAME	BETA	RISK	% 12MO RETURN	P/E	P/BV	LAST DIVIDEND	%12MO DIV. YLD.
Aeroflot - Russian Airlines OJSC	0.77	23.9	24.3	29.9	2.8	1.085	1.582
Severstal OAO	1.23	32.0	49.1	9.4	2.5	2.420	0.894
Unified Energy System JSC	1.04	40.0	10.7	23.6	0.5	0.002	0.594
Gazprom OAO	1.04	30.4	34.0	4.7	0.8	3.850	1.956
MMC Norilsk Nickel OJSC	1.10	29.4	51.3	9.7	3.3	180.000	5.539
Federal Hydrogenerating Co JSC	0.86	24.7	-11.5	33.8	0.9	N/A	N/A
Lukoil OAO	0.97	25.1	20.5	5.6	0.8	59.000	3.440

Russian Government privatization plans may lift market to the new highs.

I don't envy short-sellers in Russia.

Currently the budget deficit in Russian Federation is equal 911 bln of Rubles in jan-nov (~$29 bln, wich approximately are equal 10% of GDP), as Russian Ministry of Finance reports. And its value will increase, as Authority expects. Also there are few way to cover budget deficit (there listed in Government's plan). There are:

• tax increases,
• borrowing (issue bonds at 1 trillion Rubles),
• privatization (sell property at 1 trillion Rubles or more).

Early, at November, the Russian government has approved a privatization plan for sale of federal property in 2011-2013. As it expected, revenue of this sell-off could yield 1 trillion Rubles.

MOSCOW, November 17 (RIA Novosti)

The government hopes to get most of the privatization revenues from the sale of shares in ten major state-owned banks and companies. All decisions on the sale of these companies have been confirmed, Nabiullina said.

The list of privatizations includes the sale of shares in oil major Rosneft (RNGZY.PK, 25 percent minus one share), RusHydro hydropower generator (7.97 percent minus one share), the Federal Grid Company of Unified Energy System (4.11 percent minus one share), the country's largest shipping company Sovcomflot (50 percent minus one share), Russia's top bank Sberbank (7.58 percent minus one share), the country's second largest lender VTB bank (35.5 percent minus one share), the United Grain Company (100 percent by 2012), Rosagroleasing agricultural leasing company (50 percent minus one share from 2013), the country's rail monopoly Russian Railways (25 percent minus one share from 2013) and Russian Agricultural Bank (25 percent minus one share by 2015), Nabiullina said.

So ... Goals are obvious: "The government hopes to get most of the privatization revenues". This may mean that tax pressure increases will be delayed for a time, likely, at the first. At the second, Government need to put the stock's price on highest level. It's normal practices of initial offering. They gotta give some positive to markets.

ETF Overview: Risk Premiums for Some Countries.

"RUSSIAN RTS INDEX $ (priced in USD)" trades at eight times earning, meanwhile S&P500 has 14.891 (approximately 13-14 P/E for next year). Assume that US Equity market is correctly priced. So, based on the comparative P/E ratio we conclude that investors agree to pay only 54 cents for one dollar of profit. Is it normal? Actually I don't know. Let's estimate risk premium for some countries.

Equity Risk Premium (US).

First metric is difference between the geometric average of historical rates of returnable on equity market and 10-years Treasury Bonds - 9.26% and 4.97% respectively (for the period 1928-2009). Premium is equal 4.29% (see Historical Returns on Stocks, Bonds and Bills - United States, for instance).

Second one - difference between current or expected Earn-Price ratio and current 10-years Treasury Bonds Yield (we used current Earn-Price ratio). It's aproximately 4.09%. If we assume that expected P/E is equal 14, given this, we get 4.52%.

At the third, Implied Equity Risk Premium. Parameters used in model and results see in following table.

Are Russian Gas & Oil Producers really undervalued?

The 4 largest publicly-listed Russian Oil and Gas Producers included in RSX portfolio: OGZPY.PK (7.67%), LUKOY.PK (7.52%), SGTPY.PK (5.38%), and RNGZY.PK (7.76%).

The average P/E of presented Russian companies is equal approximately 5-6 (weighted by market cap). Is it very attractive? I don't think so.

When you invest to emerging you get more risk (it's generally accepted idea). If you get more risk be sure that risk reward is really adequate. 

Comparing Country ETFs By P/E - Government Bond Yield - GDP

Some countries have low P/E ratio, while other, by contrast, high. But this does not mean, that some countries are more attractive for investors, then other. So this simple compare may be useless. Actually, countries have different P/E ratios, but also they have different interest rates.

Let's follow the "FED" model. This comparison is more adequate. So, P/E ~ 1/r, where r is 10 year Government Bond yield. Or (P/E)*r=k, where k is adjustment coefficient. In general, Lower k may indicate cheaper equity market (under-priced or troubled). At least, lower k (k<1) means that stock price is less then it's theoretical value.