At the Water Cooler a while ago, we had a conversation about anticipated avg market returns over the next decade or so. It seemed a lot of us were concerned about lagged/not as good returns going into the future. So I have to ask, why not get into a levraged S&P ETF (e.g. UPRO - 3x multiplier), given you are optimistic on long-term market/economy? While I am aware there are some risks associated with this, I can’t say that I know them all.
Yeah, esp since I heard the 3x only applies to the upside abd the down side is one-to-one
I also heard that
But no, seriously. I hope it is a low return market for years, that should make it much easier to outperform as a fund manager.
Watch out for the decay if you hold the leveraged ETFs for a long time. However, that can be mitigated if you get 2+ asset classes and rebalance regularly.
If you want to know further, try the following exercise.
Take a look at the returns on SPY and TLT. Then take a look at the returns on their respective leveraged 2x ETFs during the same time period: SSO and UBT. See how it doesn’t really match up to 2x (usually much less.)
Then take a look at a portfolio composed of 60% SSO and 40% UBT rebalanced daily. Look at 60% SPY and 40% TLT rebalanced daily as well. You’ll see that the latter leveraged ETF portfolio probably achives closer to 2x of the respective 1x analogue portfolio.
Why would downside matter if you’re holding long-term and if, as I said, you are optimistic and anticipate an overall long-term upward trend as the market tends to show.
The additional fees will also erode some of the upside on leveraged ETFs.
How is the downside 1 to 1? I thought these things just borrow money and buy equity. Your delta wrt to equities is linear. In fact, if the market goes down, the fund is still short the bond and is paying interest on the original funding transaction.
Me thinks that comment was sarcasm. Anyway to the OP there have been studies that show these 2X/3X/etc funds don’t actually deliver those returns over longer periods and there’s a lot more volatility. Just out of curiosity, I went to google finance and the 1-month return for the S&P and UPRO are -0.12% and -0.67%, or about 5x worse. Yet the YTD return shows UPRO returning <3X the S&P while the 1 year shows it returning >3X. Lots of tracking error.
I agree that they will not provide 3x in the long term. Theyre not designed to. They are short term securities, check out their websites.
OK, they are designed to give you 3x the daily value, so if the S&P goes up 1% on monday, the ETF will go up 3%.
Sounds good, but let’s look at what happens if the market goes up 10% on monday, and down 10% on Tuesday. That’s a big number for two day, but it does make things easy to calculate for illustration.
A regular SPY ETF:
(1+10%)*(1-10%) = 1.1 * 0.9 = 0.99 --> net loss of 1%.
For the 3x fund, you’ll get (ignoring tracking error):
(1+30%)*(1-30%) = 1.3 * .7 = 0.91 --> net loss of 9%
a 2x fund will have a net loss of 4% (I’ll let you do the math on that).
So what happens is the volatility eats you. The average drag is approximately 1/2 * (volatility)^2. The more levered the fund is, the more the drag hurts you.
I did a study of SPY vs a 2x levered ETF at one point and found that over a period of 3 years, the levered ETF got a return of about 1.6x the regular SPY fund. Not quite 2x, but still more than 1x, so if you have no other choice, perhaps a levered fund is an alternative, provided that you accept that you are getting approximately 1.6x the return for 2x the volatility. Your sharpe ratio is going to go down by a factor of 1.6/2 = 0.8 or about -20%. If that’s the only way to get a higher return, maybe you decide that’s ok, but if you can borrow your own money and just buy 2x as much SPY, you’d do better doing that than buying the levered fund.
The other problem is the downside. The stock market lost over 50% from peak to trough in the 2008-9 crisis. If you had been holding a 2x fund, that would have wiped you out under a traditional leveraged position.
In fact, SSO went from about $90 per share at the peak to about $14 at the trough, which is a loss of nearly 85%. It’s true that the price recovered, but you would have had to wait about 6.5 years to get to a new high (i.e. recoup the previous losses). Meanwhile the regular S&P 500 had already recouped its losses about a year earlier. In fact, despite the fact that SSO is levered, the SPY etf is 19% above its pre-crisis high, whereas the 2x ETF is only about 4% above it’s pre-crisis high.
If a 54% decline in the S&P 500 led to an 85% decline in the SSO 2x ETF, just imagine what a 3x ETF might do to your capital. Most likely, the 3x ETF would have yet to recover its pre-crisis highs. If you could borrow 2x the cash in your account and invest in SPY, you would go broke or lose your whole position if the S&P declined again by more than 33%.
It does seem that there is an assymetry here. In good times, it better to lever by traditional methods than by using levered ETFs, However, it does seem to be marginally better in a down market to have levered ETFs vs traditional borrow-and-lever. This is because if you borrow and the security goes down, you can lose your entire amount easily. However, it looks like you will almost never lose 100% in a traditional levered ETF, but you could still lose a lot, and easily.
bchad is awesome
As far as I’m concerned… no one else needs to post. bchad, that was the ultimate response. I will reflect on this some more. I’m young and do not have much of an aversion to risk so it’s still somewhat appealing.
My thinking was exactly along the lines of what your last paragraph points out. My only concern with traditional leveraging would be defaulting on my position. That’s why I believe… if I have a fairly long-term perspective and am able to weather the storm and invest in periodic lots I would prefer the leveraged ETFs.
You make some really good points - I had not looked into recovery from declines. That is a little troubling.
How about this, then?! Hold out until next market downturn to go levered ETF, and then investment in the 3x multiplier. UPRO is up 600% since inception (mid July 2009). Granted, you can never know where the actual bottom is, but you could say buy in any time there is a 20-25%+ correction in the market. Maybe then you could extract the value from being patient in recovery.
The ETF manager says pretty clearly they are not designed to be long term holdings. They are trying to track 3x daily returns, not 3x long term returns. Buying and holding these things could work, but is much more likely to get you in trouble due to the downside risk. Measuring any returns since July 2009 can be a bit misleading since the market has essentially gone straight up since then.
If you have to just try this for yourself to learn, please don’t use a large amount of your money. I don’t want your retirement savings to have a drawdown of 70%.
Bchad’s response & the follow up from the OP just makes me think, you can lead a horse to water, but you can’t make him drink.
This statement is proof that homosexual retards do exist.
Proof that any retard could pass l1.
Lol, I kind of was just thinking out loud when I was responding and it was realllly late after going out, so I don’t really think I knew exactly what I was saying.
In all seriousness, I might dabble in these ETF’s with not much money just for fun and to be vested in the learning experience. It’s clear they should not be considered for long-term and serious investment purposes.
Blake, is that you?!!
The professor has spoken. Class dismissed.
If you want to magnify your exposure to S&P 500, you can use call options in your portfolio. Long call is essentially a leveraged position in the underlying. In a downside market your losses are capped unlike a borrow-and-lever scheme. You will need to adjust your position periodically, but not daily - you don’t care about the tracking error if your “multiplier” fluctuates within some reasonable bandwidth. You will essentially be doing what a leveraged ETF does (they use derivatives rather than borrow-and-invest), arguably at a lower cost to you.