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.
Why do leveraged ETFs drift?
Leveraged ETFs often underperform their underlying indexes leveraged by the same factor. This relative decay has several reasons: beta-slippage, roll yield, tracking errors, management fees. Roll yield may be prominent for commodity ETFs, but beta-slippage is usually the main source 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.
Monthly and yearly drift watchlist
A few simple formulas and data definitions are necessary before going to the point. “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 | -17.89% | 0.00% | 0.00% | 1.81% | 0.00% | 0.00% | |
3 | -47.83% | 5.84% | 1.95% | -9.70% | -15.13% | -5.04% | ||
-3 | NYSEARCA:SPXU | 64.99% | 11.32% | 3.77% | -14.27% | -8.84% | -2.95% | |
ICE US20+ Tbond | 1 | 20.25% | 0.00% | 0.00% | 44.03% | 0.00% | 0.00% | |
3 | 71.61% | 10.86% | 3.62% | 168.65% | 36.56% | 12.19% | ||
-3 | -44.78% | 15.97% | 5.32% | -68.79% | 63.30% | 21.10% | ||
NASDAQ 100 | 1 | -15.91% | 0.00% | 0.00% | 14.02% | 0.00% | 0.00% | |
3 | -43.53% | 4.20% | 1.40% | 24.67% | -17.39% | -5.80% | ||
-3 | 52.69% | 4.96% | 1.65% | -42.85% | -0.79% | -0.26% | ||
DJ 30 | 1 | -18.51% | 0.00% | 0.00% | -4.18% | 0.00% | 0.00% | |
3 | -48.89% | 6.64% | 2.21% | -24.46% | -11.92% | -3.97% | ||
-3 | 68.28% | 12.75% | 4.25% | 2.55% | -9.99% | -3.33% | ||
Russell 2000 | 1 | -21.91% | 0.00% | 0.00% | -12.88% | 0.00% | 0.00% | |
3 | -55.33% | 10.40% | 3.47% | -45.16% | -6.52% | -2.17% | ||
-3 | 91.12% | 25.39% | 8.46% | 28.41% | -10.23% | -3.41% | ||
S&P Select Energy | 1 | -37.56% | 0.00% | 0.00% | -43.31% | 0.00% | 0.00% | |
3 | -82.17% | 30.51% | 10.17% | -88.66% | 41.27% | 13.76% | ||
-3 | 209.92% | 97.24% | 32.41% | 257.09% | 127.16% | 42.39% | ||
MSCI US REIT | 1 | -12.46% | 0.00% | 0.00% | 3.38% | 0.00% | 0.00% | |
3 | -34.05% | 3.33% | 1.11% | -5.79% | -15.93% | -5.31% | ||
-3 | 37.48% | 0.10% | 0.03% | -14.86% | -4.72% | -1.57% | ||
ARCA Gold Miners | 1 | -3.84% | 0.00% | 0.00% | 22.95% | 0.00% | 0.00% | |
3 | -16.05% | -4.53% | -1.51% | 31.28% | -37.57% | -12.52% | ||
-3 | -1.16% | -12.68% | -4.23% | -67.50% | 1.35% | 0.45% | ||
MSCI Emerging | 1 | -14.96% | 0.00% | 0.00% | -7.59% | 0.00% | 0.00% | |
3 | -40.81% | 4.07% | 1.36% | -33.12% | -10.35% | -3.45% | ||
-3 | 54.72% | 9.84% | 3.28% | 12.52% | -10.25% | -3.42% | ||
Gold spot | 1 | 7.06% | 0.00% | 0.00% | 28.47% | 0.00% | 0.00% | |
3 | 20.40% | -0.78% | -0.26% | 89.13% | 3.72% | 1.24% | ||
-3 | -20.64% | 0.54% | 0.18% | -54.43% | 30.98% | 10.33% | ||
Silver spot | 1 | -4.51% | 0.00% | 0.00% | 10.20% | 0.00% | 0.00% | |
3 | -17.05% | -3.52% | -1.17% | 5.89% | -24.71% | -8.24% | ||
-3 | 9.73% | -3.80% | -1.27% | -38.93% | -8.33% | -2.78% | ||
S&P Biotech Select | 1 | -13.84% | 0.00% | 0.00% | -4.18% | 0.00% | 0.00% | |
3 | -40.23% | 1.29% | 0.43% | -34.66% | -22.12% | -7.37% | ||
-3 | 42.48% | 0.96% | 0.32% | -23.30% | -35.84% | -11.95% | ||
PHLX Semicond. | 1 | -18.61% | 0.00% | 0.00% | 19.39% | 0.00% | 0.00% | |
3 | -49.70% | 6.13% | 2.04% | 26.81% | -31.36% | -10.45% | ||
-3 | 62.05% | 6.22% | 2.07% | -62.53% | -4.36% | -1.45% | ||
VIX ST Futures | 1 | 167.70% | 0.00% | 0.00% | 13.47% | 0.00% | 0.00% | |
2 | 498.54% | 163.14% | 81.57% | -25.16% | -52.10% | -26.05% |
*TVIX is an ETN with a higher counterparty risk than an ETF.
The best and worst drifts
- The inverse leveraged gold miners ETF (DUST) has the worst monthly decay with a drift of -4.23% normalized to 1x the underlying index exposure.
- The highest positive monthly drift is in the leveraged volatility ETN (TVIX), with a drift of +81.57% normalized to 1x the index exposure.
- However, TVIX is showing the worst decay in 1 year with a normalized drift of -26.05%.
- The highest positive drift in 1 year is for the inverse leveraged ETF in energy (ERY) with a normalized drift of almost +42.39%.
SPXU historical and current drift: a warning signal
The 12-month trade drifts of the long and inverse leveraged ETFs in stock indexes became all negative this month. SPXU has a positive drift on long periods, as reported in this article. In fact, the average 1-year normalized drift of SPXU since it is computable (1 year after inception) is about 1%, as shown on the next chart.
SPXU may be a cheap instrument for hedging a portfolio in a bull market compared with other derivatives. However, its drift became negative last week and history tells it could stay negative a few months. It may suffer a significant decay as long as market daily returns stay volatile.
Hedging with SPXU has worked very well in the first week of the 2020 black swan (2/21 to 2/28): SPXU has gained 39.98%, significantly more than SPY return on the same period of time (-11.16%) multiplied by the leveraging ratio (-3). In this unexpected sharp fall of the stock market, hedging with SPXU brought significant excess return over hedging with non-leveraged products or S&P 500 futures. It was a one-way week and we can't expect all weeks to be one-way. SPXU did a great job when the black swan started, but investors using SPXU as a hedge should be cautious from now: high volatility may become the new normal in the next few months. The real drift of a hedging position depends on its rebalancing dates. Rebalancing may offset a part of the decay in a volatile market. However, the process is path dependent and may not work the same way in the future as in the past. In doubt, it is better to use hedging instruments with less or no leverage in a volatile environment. I extend this warning to all leveraged equity ETFs, long and inverse.
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.
