Leveraged ETF Decays - Update

Jul. 03, 2019 11:08 AM ETBDCL, 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, TVIXF, TZA, UDOW, UGLDF, UPRO, USLVF, VIXY, VNQ, XBI, XLE6 Comments5 Likes

Summary

  • Theoretical reminder.
  • 1-month and 1-year drifts of major leveraged ETFs.
  • The worst and the best ETF drifts.
  • This idea was discussed in more depth with members of my private investing community, Quantitative Risk & Value. Start your free trial today »

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, 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 7/2/2019

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 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

7.93%

0.00%

0.00%

11.30%

0.00%

0.00%

3

UPRO

24.53%

0.74%

0.25%

19.82%

-14.08%

-4.69%

-3

SPXU

-20.25%

3.54%

1.18%

-31.18%

2.72%

0.91%

ICE US20+ Tbond

1

TLT

0.71%

0.00%

0.00%

11.43%

0.00%

0.00%

3

TMF

1.33%

-0.80%

-0.27%

28.39%

-5.90%

-1.97%

-3

TMV

-2.14%

-0.01%

0.00%

-26.82%

7.47%

2.49%

NASDAQ 100

1

QQQ

9.04%

0.00%

0.00%

11.52%

0.00%

0.00%

3

TQQQ

27.90%

0.78%

0.26%

13.17%

-21.39%

-7.13%

-3

SQQQ

-23.54%

3.58%

1.19%

-40.46%

-5.90%

-1.97%

DJ 30

1

DIA

7.81%

0.00%

0.00%

12.75%

0.00%

0.00%

3

UDOW

24.19%

0.76%

0.25%

24.76%

-13.49%

-4.50%

-3

SDOW

-19.96%

3.47%

1.16%

-34.01%

4.24%

1.41%

Russell 2000

1

IWM

7.40%

0.00%

0.00%

-3.23%

0.00%

0.00%

3

TNA

22.21%

0.01%

0.00%

-23.20%

-13.51%

-4.50%

-3

TZA

-19.57%

2.63%

0.88%

-2.52%

-12.21%

-4.07%

S&P Select Energy

1

XLE

9.50%

0.00%

0.00%

-12.66%

0.00%

0.00%

3

ERX

28.79%

0.29%

0.10%

-45.68%

-7.70%

-2.57%

-3

ERY

-24.45%

4.05%

1.35%

25.41%

-12.57%

-4.19%

MSCI US REIT

1

VNQ

1.51%

0.00%

0.00%

12.19%

0.00%

0.00%

3

DRN

1.99%

-2.54%

-0.85%

18.80%

-17.77%

-5.92%

-3

DRV

-3.12%

1.41%

0.47%

-30.83%

5.74%

1.91%

ARCA Gold Miners

1

GDX

13.85%

0.00%

0.00%

12.68%

0.00%

0.00%

3

NUGT

42.92%

1.37%

0.46%

5.68%

-32.36%

-10.79%

-3

DUST

-35.34%

6.21%

2.07%

-50.09%

-12.05%

-4.02%

MSCI Emerging

1

EEM

7.47%

0.00%

0.00%

4.03%

0.00%

0.00%

3

EDC

22.41%

0.00%

0.00%

-5.77%

-17.86%

-5.95%

-3

EDZ

-19.70%

2.71%

0.90%

-23.45%

-11.36%

-3.79%

Gold spot

1

GLD

5.91%

0.00%

0.00%

10.49%

0.00%

0.00%

3

UGLD

17.89%

0.16%

0.05%

22.45%

-9.02%

-3.01%

-3

DGLD

-16.63%

1.10%

0.37%

-24.88%

6.59%

2.20%

Silver spot

1

SLV

3.88%

0.00%

0.00%

-5.91%

0.00%

0.00%

3

USLV

10.56%

-1.08%

-0.36%

-28.95%

-11.22%

-3.74%

-3

DSLV

-11.71%

-0.07%

-0.02%

11.73%

-6.00%

-2.00%

Wells Fargo BDC

1

BDCS

4.04%

0.00%

0.00%

7.91%

0.00%

0.00%

2

BDCL

7.26%

-0.82%

-0.41%

11.36%

-4.46%

-2.23%

S&P Biotech Select

1

XBI

11.09%

0.00%

0.00%

-6.20%

0.00%

0.00%

3

LABU

33.85%

0.58%

0.19%

-44.15%

-25.55%

-8.52%

-3

LABD

-30.29%

2.98%

0.99%

-32.97%

-51.57%

-17.19%

PHLX Semicond.

1

SOXX

15.71%

0.00%

0.00%

15.89%

0.00%

0.00%

3

SOXL

51.43%

4.30%

1.43%

14.88%

-32.79%

-10.93%

-3

SOXS

-38.52%

8.61%

2.87%

-58.49%

-10.82%

-3.61%

VIX ST Futures

1

VIXY

-19.55%

0.00%

0.00%

-35.70%

0.00%

0.00%

2

TVIX

-34.33%

4.77%

2.39%

-69.74%

1.66%

0.83%

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

In 1 month:

  • The leveraged real estate ETF (DRN) has the worst monthly decay with a -0.85% drift normalized to 1x the underlying index exposure. There was no dramatic decay in the list during the month of June.
  • The highest positive monthly drift is in the inverse leveraged semiconductors ETF (SOXS) with a 2.87% drift normalized to 1x the underlying index exposure, in a large loss. The leveraged volatility ETN (TVIX) and the inverse leveraged gold miners ETF (DUST) also have positive drifts above 2% in large losses.

In 1 year:

  • The worst decay is in the leveraged inverse biotechnology ETF (LABD), with a normalized drift of -17.2%. Leveraged ETFs in semiconductors (SOXL) and miners (NUGT) also show a normalized drift beyond -10%. The 3 underlying industries have suffered from high volatility resulting in significant decays for long and inverse products.
  • The highest positive drift is for the inverse T-bond ETF (TMV), followed by the inverse leveraged gold ETF (DGLD). Both show a normalized drift above 2%, but heavy losses.

The 12-month drift of inverse leveraged ETFs in the S&P 500 (SPXU) and the Dow Jones Industrial Average (SDOW) are positive again, despite volatility in the last quarter of 2018. These products have historically positive drifts on longer time frames: check here the drifts on 3-year and 7-year periods. It shows once again that these products may be cheap hedging instruments compared with other derivatives. The real drift of a hedging position depends on when it is rebalanced. From my intuition and experience, it is better to rebalance close to technical support and resistance zones. The 12-month drifts stay negative for the long and inverse leveraged ETFs based on the Nasdaq 100 and Russell 2000, which have been more volatile. Shorting an asset or buying an inverse product also implies a drift due to inflation. Whatever the asset and the price action, a non-leveraged short or inverse position suffers a negative bias equal to the inflation rate. It has not been a big concern in the recent years, but it’s better to keep it in mind.

Since 2015, Quantitative Risk & Value (QRV) provides a systemic risk indicator and strategies based on it. SPXU may be used in hedging tactics scaled according to the market’s risk level and the investor’s risk tolerance. In a world of probabilities, it is a more realistic approach than just risk on/risk off. Get started with a two-week free trial and see how QRV can improve your investing decisions.

This article was written by

Fred Piard profile picture
14.26K Followers
Data-driven model portfolios and market risk indicators.
Author of Quantitative Risk & Value and three books, I have been investing in systematic strategies since 2010. I have a PhD in computer science, an MSc in software engineering, an MSc in civil engineering and 30 years of professional experience in various sectors. My aim is making simple and efficient quantitative investing techniques available to my followers. Quantitative models can make investment decisions faster, reproducible and emotionless by focusing on relevant information in the middle of market noise. Moreover, models can be refined to meet specific risk tolerance and objectives. 

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I am an individual investor and an IT professional, not a finance professional. My writings are data analysis and opinions, not investment advice. They may contain inaccurate information, despite all the effort I put in them. Readers are responsible for all consequences of using information included in my work, and are encouraged to do their own research from various sources.

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Disclosure: I am/we are long SPY, QQQ, XBI, TLT. 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.

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