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, VIXY, VNQ, 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 2/1/2019

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 followed, 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 two 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

8.01%

0.00%

0.00%

-2.38%

0.00%

0.00%

3

UPRO

23.89%

-0.14%

-0.05%

-20.55%

-13.41%

-4.47%

-3

SPXU

-21.27%

2.76%

0.92%

-3.86%

-11.00%

-3.67%

ICE US20+ Tbond

1

TLT

0.38%

0.00%

0.00%

2.69%

0.00%

0.00%

3

TMF

0.41%

-0.73%

-0.24%

0.96%

-7.11%

-2.37%

-3

TMV

-0.77%

0.37%

0.12%

-7.93%

0.14%

0.05%

NASDAQ 100

1

QQQ

9.01%

0.00%

0.00%

0.52%

0.00%

0.00%

3

TQQQ

26.92%

-0.11%

-0.04%

-19.30%

-20.86%

-6.95%

-3

SQQQ

-25.24%

1.79%

0.60%

-24.45%

-22.89%

-7.63%

DJ 30

1

DIA

7.33%

0.00%

0.00%

-1.99%

0.00%

0.00%

3

UDOW

21.81%

-0.18%

-0.06%

-20.32%

-14.35%

-4.78%

-3

SDOW

-20.00%

1.99%

0.66%

-6.47%

-12.44%

-4.15%

Russell 2000

1

IWM

11.32%

0.00%

0.00%

-4.03%

0.00%

0.00%

3

TNA

35.69%

1.73%

0.58%

-25.14%

-13.05%

-4.35%

-3

TZA

-28.45%

5.51%

1.84%

-1.44%

-13.53%

-4.51%

S&P Select Energy

1

XLE

11.21%

0.00%

0.00%

-12.14%

0.00%

0.00%

3

ERX

35.12%

1.49%

0.50%

-45.77%

-9.35%

-3.12%

-3

ERY

-28.93%

4.70%

1.57%

16.44%

-19.98%

-6.66%

MSCI US REIT

1

VNQ

11.85%

0.00%

0.00%

11.75%

0.00%

0.00%

3

DRN

37.98%

2.43%

0.81%

24.94%

-10.31%

-3.44%

-3

DRV

-28.68%

6.87%

2.29%

-37.23%

-1.98%

-0.66%

ARCA Gold Miners

1

GDX

7.59%

0.00%

0.00%

-2.73%

0.00%

0.00%

3

NUGT

21.94%

-0.83%

-0.28%

-31.62%

-23.43%

-7.81%

-3

DUST

-20.82%

1.95%

0.65%

-19.26%

-27.45%

-9.15%

MSCI Emerging

1

EEM

10.34%

0.00%

0.00%

-12.96%

0.00%

0.00%

3

EDC

31.92%

0.90%

0.30%

-46.09%

-7.21%

-2.40%

-3

EDZ

-26.45%

4.57%

1.52%

21.96%

-16.92%

-5.64%

Gold spot

1

GLD

2.89%

0.00%

0.00%

-1.62%

0.00%

0.00%

3

UGLD

7.91%

-0.76%

-0.25%

-13.48%

-8.62%

-2.87%

-3

DGLD

-7.68%

0.99%

0.33%

6.38%

1.52%

0.51%

Silver spot

1

SLV

3.65%

0.00%

0.00%

-6.81%

0.00%

0.00%

3

USLV

9.89%

-1.06%

-0.35%

-30.52%

-10.09%

-3.36%

-3

DSLV

-9.98%

0.97%

0.32%

9.80%

-10.63%

-3.54%

Wells Fargo BDC

1

BDCS

12.63%

0.00%

0.00%

5.30%

0.00%

0.00%

2

BDCL

25.60%

0.34%

0.17%

6.67%

-3.93%

-1.97%

S&P Biotech Select

1

XBI

16.52%

0.00%

0.00%

-11.84%

0.00%

0.00%

3

LABU

50.91%

1.35%

0.45%

-53.17%

-17.65%

-5.88%

-3

LABD

-41.14%

8.42%

2.81%

-18.48%

-54.00%

-18.00%

PHLX Semicond.

1

SOXX

10.06%

0.00%

0.00%

-4.49%

0.00%

0.00%

3

SOXL

27.74%

-2.44%

-0.81%

-36.70%

-23.23%

-7.74%

-3

SOXS

-30.93%

-0.75%

-0.25%

-28.34%

-41.81%

-13.94%

VIX ST Futures

1

VIXY

-24.50%

0.00%

0.00%

14.85%

0.00%

0.00%

2

TVIX

-43.79%

5.21%

2.61%

-39.42%

-69.12%

-34.56%

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

In one month:

  • The leveraged ETF in semiconductors (SOXL) has the worst monthly decay with a drift of -0.8% normalized to 1x the underlying index exposure.

  • The highest positive monthly drift is in the inverse leveraged biotechnology ETF (LABD) with a drift of +2.8% normalized to 1x the underlying index exposure. Inverse leveraged ETFs in REITs (DRV) and volatility (TVIX) also have drifts over 2%. These drifts happened in large losses due to a steady rally in underlying indexes.

In one year:

  • The worse decay was in leveraged volatility (TVIX) with a normalized drift of -34.6%. The inverse leveraged ETFs in biotechnology (LABD) and semiconductors (SOXS) have suffered normalized decays over 10% on the underlying index exposure.

  • The highest positive drift is for the inverse leveraged gold ETF (DGLD), but it is quite small: +0.5% 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. SPXU, which had a positive Trade Drift of 7.9% in 2017, has suffered a 3.7% decay in the last 12 months (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. Moreover, it shows a strong positive drift in January. However, if 2019 happens to be another volatile year, a product with a lower leverage may be more appropriate.

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.

Additional disclosure: I hold SPXU as a partial hedge of my stock portfolio.