For those who like to invest in the market ETFs, there is variety of choices. When comparing the performance of different investment, the concept that higher return means higher risk is meaningful only when the risk/ reward ratio stay on the same line. It is not necessarily true that the risk/ reward ratios for multiple investments all fall on the same line. It is important to quantify the risk and return instead of conjecturing up a number. The modern portfolio theory says that the ratio of risk/ reward can be adjusted. There are ways to construct a portfolio that has the same risk as a benchmarking portfolio or stock but higher return, or has the same return but lower risk.

There are two measures of the risks: beta and standard deviation. Beta is measured against the market and standard deviation is measured against stock's own price performance, which is the standalone risk of an investment. The higher the standard deviation, the higher the risk is. For highly diversified portfolio, the beta approaches to one, because it represents the market itself.

In this article, let us compare ETRACS Monthly Pay 2xLeveraged Closed-End Fund ETN (NYSEARCA:CEFL) and ProShares Ultra QQQ ETF (NYSEARCA:QLD). Both CEFL and QLD are highly diversified; and both are 2x leveraged. Even though their components are different, however, they are sufficiently diversified, both of them can represent the market and the standalone risk is minimized. The only significant risk is the market risk.

Since the CEFL started trading on January 7, 2014, the data are limited, instead of using the yearly return to calculate the standard deviation; we use the daily return to calculate the standard deviation. Furthermore, we also determine the cases of CEFL price with and without adjustment by dividends. The result is summarized in the table below:

For the comparison purpose, we also list QQQ, which is the non-leveraged version of QLD. We can see that for roughly 5 months (from January, 7, 2014 to June 11, 2014), the standard deviation for CEFL without dividend adjustment, CEFL adjusted by dividend, QLD and QQQ are 0.84%, 0.79%, 1.86% and 0.93%, respectively, and their returns are 7.92%, 17.38%, 12.97% and 7.3% respectively. The standard deviation of QQQ is exactly half of that of QLD, as expected. QQQ return is slightly higher than the half of QLD return because of its dividend.

The price trend charts are shown below using the price data from Yahoo Finance. We can see that CEFL roughly correlates to QLD. The higher QLD standard deviation is visible as larger price swing than CEFL, therefore, higher risk.

The chart below plots their relative positions in the risk /reward map using the data from the table above. Not surprisingly, we can draw a line to correlate QLD, QQQ and CEFL (without dividend) nicely. All these three investments do indeed fall on the same risk /reward line that is risk is proportional to the return. However, it is interesting to note that despite CEFL is 2 x leveraged, its risk level is almost the same as QQQ, which is not leveraged. This is certainly due to its composition. CEFL consists of 60% of high yield equity funds, 25% of high yield debt funds, and other high income asset classes. Therefore, CEFL has composition more diversified than QLD, which tracks NASDAQ 100. Its diversification balances out the higher risk in leverage.

When we include dividend in CEFL price, we get a very different result. The return jumped from 7.92% to 17.38%. The additional yield of 9.46% comes entirely from dividend, which does not increase the risk. Therefore, dividend improves the relative risk / reward ratio. This is why dividend is such an important element in the total investment return. This analysis shows that CEFL has lower risk than QLD and yet higher return within the limit timeframe available for comparison analysis.

Please note that the present analysis is for a very limited period. Future performance may not hold true. It also only takes into account the standard deviation risk, not the beta risk. Therefore, it can only be used to compare between two investments. It is not an absolute evaluation of the investment. Neither the timing is considered here. In addition, the dividend adjustment of stock price is done on the ex-dividend dates. For those who receive dividend in cash or using dividend reinvestment after receiving the dividend, the results may also be different. However, such an analysis can be used to compare two different investments for their risk to return assessment.

**Conclusion:**

When making an investment decision, it is always important to understand the return vs. risk. To do such analysis, I have presented a simple, yet powerful method. The stock data are taken from Yahoo Finance, and downloaded into Excel. It is a laborious work if you are doing a lot of comparisons.

**Disclosure: **The author is long CEFL. 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.