Leveraged ETF Decays - Update

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Includes: BDCL, BDCS, DGLD, DIA, DRN, DRV, DSLV, DUST, EDC, EDZ, EEM, ERX, ERY, GDX, GLD, IWM, LABD, LABU, NUGT, QQQ, SDOW, SLV, SOXL, SOXS, SOXX, SPXU, SPY, SQQQ, TLT, TMF, TMV, TNA, TQQQ, TVIX, TZA, UDOW, UGLD, UPRO, USLV, VNQ, VXX, XBI, XLE
by: Fred Piard
Summary

Theoretical reminder.

One-month and one-year drifts of major leveraged ETFs.

The worst decays and the best positive drifts.

I measure once a month the decay of major leveraged ETFs. It may be useful for anyone using leveraged ETFs for investing, trading, or hedging.

Where does the decay come from?

Most of the time, a leveraged ETF does worse than the underlying asset leveraged by the same factor. This relative decay has several reasons: beta-slippage, roll yield, tracking errors, and management fees. Only the latter is predictable. Roll yield may be prominent for commodity ETFs (leveraged or not), but beta-slippage is usually the main reason of decay. However, it doesn't always result in decay. When an asset is trending with little volatility, a leveraged ETF can bring an excess return over the leveraged asset. You can click here to learn more about beta-slippage and examples.

The leveraged ETF decay looks like an invitation to short sellers. Click here if you want to know why it is bad idea.

Monthly and Yearly Drifts on 1/6/2019

Definitions are needed. "Lev" is the leveraging factor. "Return" is the total return of an ETF (including dividends). "IndexReturn" is the total return of the underlying index, measured on a non-leveraged ETF (also with dividends). "ETFdrift" is the drift of the ETF relative to the leveraged index. "TradeDrift" is the drift relative to an equivalent position in the non-leveraged index. ETFdrift and TradeDrift are calculated as follows, where Abs is the absolute value operator.

ETFdrift = Return - (IndexReturn x Lev)

TradeDrift = ETFdrift / Abs(Lev.)

"Decay" is negative drift. "Month" stands for 21 trading days; "year" for 252 trading days.

A drift is a difference between 2 returns, so it can be below -100%.

Index

Lev.

Ticker

1-month Return

1-month ETFdrift

1-month TradeDrift

1-year Return

1-year ETFdrift

1-year TradeDrift

S&P 500

1

SPY

-9.11%

0.00%

0.00%

-4.91%

0.00%

0.00%

3

UPRO

-27.33%

0.00%

0.00%

-26.38%

-11.65%

-3.88%

-3

SPXU

27.61%

0.28%

0.09%

4.09%

-10.64%

-3.55%

ICE US20+ Tbond

1

TLT

5.63%

0.00%

0.00%

-0.52%

0.00%

0.00%

3

TMF

17.27%

0.38%

0.13%

-7.67%

-6.11%

-2.04%

-3

TMV

-15.32%

1.57%

0.52%

0.68%

-0.88%

-0.29%

NASDAQ 100

1

QQQ

-9.08%

0.00%

0.00%

-1.55%

0.00%

0.00%

3

TQQQ

-28.09%

-0.85%

-0.28%

-23.41%

-18.76%

-6.25%

-3

SQQQ

23.07%

-4.17%

-1.39%

-19.22%

-23.87%

-7.96%

DJ 30

1

DIA

-9.21%

0.00%

0.00%

-3.91%

0.00%

0.00%

3

UDOW

-27.60%

0.03%

0.01%

-24.72%

-12.99%

-4.33%

-3

SDOW

27.60%

-0.03%

-0.01%

-0.70%

-12.43%

-4.14%

Russell 2000

1

IWM

-10.66%

0.00%

0.00%

-9.88%

0.00%

0.00%

3

TNA

-31.11%

0.87%

0.29%

-37.60%

-7.96%

-2.65%

-3

TZA

33.57%

1.59%

0.53%

18.88%

-10.76%

-3.59%

S&P Select Energy

1

XLE

-10.58%

0.00%

0.00%

-17.25%

0.00%

0.00%

3

ERX

-31.28%

0.46%

0.15%

-54.45%

-2.70%

-0.90%

-3

ERY

31.27%

-0.47%

-0.16%

38.18%

-13.57%

-4.52%

MSCI US REIT

1

VNQ

-8.75%

0.00%

0.00%

-5.72%

0.00%

0.00%

3

DRN

-27.48%

-1.23%

-0.41%

-25.53%

-8.37%

-2.79%

-3

DRV

28.83%

2.58%

0.86%

4.52%

-12.64%

-4.21%

ARCA Gold Miners

1

GDX

10.15%

0.00%

0.00%

-9.15%

0.00%

0.00%

3

NUGT

28.25%

-2.20%

-0.73%

-45.63%

-18.18%

-6.06%

-3

DUST

-29.29%

1.16%

0.39%

-1.62%

-29.07%

-9.69%

MSCI Emerging

1

EEM

-3.87%

0.00%

0.00%

-16.34%

0.00%

0.00%

3

EDC

-12.72%

-1.11%

-0.37%

-51.99%

-2.97%

-0.99%

-3

EDZ

10.85%

-0.76%

-0.25%

37.58%

-11.44%

-3.81%

Gold spot

1

GLD

4.32%

0.00%

0.00%

-2.71%

0.00%

0.00%

3

UGLD

12.69%

-0.27%

-0.09%

-15.94%

-7.81%

-2.60%

-3

DGLD

-11.75%

1.21%

0.40%

9.22%

1.09%

0.36%

Silver spot

1

SLV

9.19%

0.00%

0.00%

-8.91%

0.00%

0.00%

3

USLV

28.95%

1.38%

0.46%

-35.73%

-9.00%

-3.00%

-3

DSLV

-23.70%

3.87%

1.29%

17.56%

-9.17%

-3.06%

Wells Fargo BDC

1

BDCS

-5.74%

0.00%

0.00%

-3.99%

0.00%

0.00%

2

BDCL

-13.40%

-1.92%

-0.96%

-11.64%

-3.66%

-1.83%

S&P Biotech Select

1

XBI

-11.34%

0.00%

0.00%

-14.92%

0.00%

0.00%

3

LABU

-34.82%

-0.80%

-0.27%

-57.38%

-12.62%

-4.21%

-3

LABD

27.11%

-6.91%

-2.30%

-9.11%

-53.87%

-17.96%

PHLX Semicond.

1

SOXX

-9.80%

0.00%

0.00%

-11.37%

0.00%

0.00%

3

SOXL

-31.01%

-1.61%

-0.54%

-48.89%

-14.78%

-4.93%

-3

SOXS

24.29%

-5.11%

-1.70%

-8.00%

-42.11%

-14.04%

VIX ST Futures

1

VXX

35.20%

0.00%

0.00%

66.57%

0.00%

0.00%

2

TVIX

72.62%

2.22%

1.11%

23.94%

-109.20%

-54.60%

BDCL and TVIX are exchange-traded notes. ETNs entail additional counterparty risks.

In one month:

  • The inverse leveraged biotechnology ETFs (LABD) has the worst monthly decay with a -2.3% drift normalized to 1x the underlying index exposure. The inverse leveraged ETFs in semiconductors (SOXS) and the Nasdaq 100 index (SQQQ) have also suffered normalized decays above 1%.

  • The highest positive monthly drifts are for the inverse leveraged silver ETF (DSLV) and the leveraged VIX ETN (TVIX), with respective drifts of +1.29% and +1.11% normalized to 1x the underlying index exposure.

In one year:

  • The worse decay was in leveraged volatility (TVIX) with a normalized drift of -54.6%. The inverse leveraged ETF in biotechnology (LABD) and semiconductors (SOXS) have suffered normalized decays over 10% on the underlying index exposure.

  • The only yearly positive drift in the list is for the inverse leveraged gold ETF (DGLD) with a small +0.36% normalized to the underlying index.

Due to stock volatility in 2018, leveraged ETFs in major stock indexes, both long and inverse, are in negative drift last 12 months. For example, SPXU, which had a positive Trade Drift of 7.9% in 2017, has suffered a 3.6% decay in 2018 (normalized to 1x SP 500 exposure). Investors using it for hedging for two years or more (like me) are still happy with SPXU's behavior, but if 2019 happens to be another volatile year, it may be better reducing the hedge ratio or switching to a product with a lower leverage. Apart from limiting negative drifts, Meb Faber explains here another benefit of reducing the short side when the market drops.

Keep also in mind that shorting an asset or buying an inverse product (leveraged or not) implies an additional systematic decay due to inflation. Whatever the price action, a short position (non-leveraged) suffers a negative bias equal to the inflation rate.

Disclosure: I am/we are long QQQ,XBI,SPXU. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.