Does Broadly Shorting Inverse Leveraged ETPs Work?

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 |  Includes: EDZ, GLL, SCO, SPXU, TMV, TZA, ZSL
by: Harry Long

Summary

There are a variety of leveraged inverse ETPs.

Readers have asked me to test shorting a broad basket.

Here are the results.

Does broadly shorting inverse leveraged ETPs work? The available data shows that randomly shorting leveraged inverse ETPs might perform well in certain time periods and horribly in others. So the simple answer is that one would probably not want to randomly short a basket of such ETPs, especially when a carefully chosen selection such as Hedged Convexity Capture can far outperform shorting a random broad basket.

Let's take a look at the data using the following rules:

I. Short SPXU (NYSEARCA:SPXU), TZA (NYSEARCA:TZA), EDZ (NYSEARCA:EDZ), TMV (NYSEARCA:TMV), GLL (NYSEARCA:GLL), ZSL (NYSEARCA:ZSL), and SCO (NYSEARCA:SCO) with equal dollar weights at 14.285% each.

II. Rebalance weekly to maintain the equal dollar weighting between the positions.

Here are the results of shorting inverse leveraged ETPs for U.S. stocks, Emerging Market stocks, 20+ year government bonds, Gold, Silver, and Oil:

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At first glance, randomly shorting a broad basket of inverse leveraged ETPs might look alright, but I would urge caution and note some methodological problems here. Of the seven ETPs, three are linked to equities, three are linked to commodities, and one is fixed income. However, the three equity ETPs are leveraged -3X, while the commodity ETPs are leveraged -2X. In effect, the basket has benefited from a bull market in equities. However, the dollar underweighting of 20+ year government bonds has probably lowered the Sharp ratio as well, hurting the performance of the basket.

So let's make some imperfect, but simple adjustments. Let's weight the three equity ETPs at 10% each, for a 30% dollar equity ETP exposure. Let's weight the three commodity ETPs at 15% each, for a 45% dollar commodity ETP exposure (remember, they are only -2X, hence the higher dollar weighting). And let's weight TMV at 25% to get our government bond exposure somewhat comparable to the equity and commodity ETP exposure. These adjustments are imperfect, but rational if we are going to get a more realistic broad basket test.

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This is a more realistic basket, but there are still some methodological problems. The basket does not have Europe or Japan exposure, which would have affected the performance. In addition, even though this broad basket looks alright on the surface, it far underperforms Hedged Convexity Capture on both a Sharpe and MAR basis.

But what really bothers me about the broad basket's performance is its inconsistency. An institutional strength approach should have somewhat consistent performance across different time periods, rather than feast and famine performance.

In the last 24 months, the more realistic broad basket's performance has been downright scary:

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Given the totally inconsistent performance, randomly broadly shorting inverse leveraged ETPs might inconsistently work. But given the results, responsible investors shouldn't try it.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.