Tracking Trouble for the Triple-Levered ETFs

I’ve written here before about my general dismay with triple-levered exchange-traded funds -– I might have called them basement financial bomb-building kits, but I don’t recall … -– and so I was caught by this graphic in a new Bespoke Premium report.

Neither the triple-levered bullish or bearish ETFs are anywhere close to the daily performance of the underlying index, which is the Russell Energy. And that’s not the only sector with massive (levered) tracking errors.

Comments

[dfx:]

yes, but people don't buy these to track the index per se, they trade them to gamble. the only real reason to wish it tracks the index precisely is if you want to use the index to tell you what might be about to happen.
I'm more concerned with the spastic bid/ask jumping beans.

2008 Dec 04 06:46 AM

[Alan Brochs...:]

Paul, it's called whipsaw... These things are rebalanced DAILY. Over the time-frame that you included, the underlying index did nothing from start to finish, but it was very volatile over that time-frame. I don't have the time to work the example you cited, but consider this pattern:

+3%, -5%, +10%, -7% - that get's you about a zero return over four days.

Triple long +9%, -15%, +30%, -21% - that gets you a 5% loss

It's a math thing. As any trader knows, if you lose 1/2 your money, you have to make a 100% on the balance to get back to even. If you lose 1% of your money, you have to make just a little more than 1% to get it back.

The moral of the story is that these instruments aren't for long-term holds unless the market is trending

2008 Dec 04 08:48 AM

[DonaldRay:]

Very good reply Allan..that is exactly correct. I might enhance your answer with that they are trading vehicles and not investment vehicles.

Paul, you just leave the big money to us.

2008 Dec 04 07:45 PM

[boogie60:]

most people are lazy, if you look at their make up, XOM and CVX are extremely large. where they go, these etf's go, and fast.

2008 Dec 04 10:04 PM

[BrucePile:]

All but the 1X short ETFs are worthless for trading or investing because they are so inaccurate. All of the error is biased against the short seller. Where does all the mismatched money go anyway? Does the ETF company, Proshares, pocket the difference? Shouldn't there be investigations and lawsuits flying over this? The 1X are much more accurate and actually outperform the "ultra" short version in market declines. The 2X short ETF is actually a much better way of taking advantage of a down market than taking a short position - if they would just work like they're supposed to.

2008 Dec 05 04:56 PM

[GeorgeK:]

I understand how daily rebalancing means that a levered etf will underperform the fund, and dramatically so if there is high volatility. I was attracted to short etfs because I was reluctant to change my brokerage account to a margin account so I could short. However, using the mathematics of daily rebalancing, you could basically be guaranteed to make money by shorting both the long and short levered etfs of a volatile index. Using this method you would have made about 27% on erx and ery in less than a month. Is there anything that would prevent you from doing this?

2008 Dec 05 06:45 PM

[Manray:]

That works if the index is close to unchanged over some time period (and some other circumstances depending on how volatile the index is). If daily changes were +10%, +10%, +10%, +10%, the 2x long would be up 107% and the 2x short would be down 59%. Shorting both would lose money.

On Dec 05 06:45 PM GeorgeK wrote:
> I understand how daily rebalancing means that a levered etf will
> underperform the fund, and dramatically so if there is high volatility.
> I was attracted to short etfs because I was reluctant to change my
> brokerage account to a margin account so I could short. However,
> using the mathematics of daily rebalancing, you could basically be
> guaranteed to make money by shorting both the long and short levered
> etfs of a volatile index. Using this method you would have made
> about 27% on erx and ery in less than a month. Is there anything
> that would prevent you from doing this?

2008 Dec 05 09:55 PM