How To Beat Leveraged ETF Decay
May. 23, 2013 12:08 PM
Leveraged Exchange Trade Funds (ETFs) and related Exchange Trade Notes (ETNs) aim to provide investors with a multiple (2x, 3x) or inverse multiple (-2x, -3x) of an underlying asset's or benchmark's daily movement. While in the right hands these funds can be an extremely powerful tool, the nature of the beast is that the methods used to produce leveraged price movements inevitably erode away the long-term performance of these funds.
As a result, Spivak summarizes the typical sentiment investors hold regarding leveraged funds:
". it is NOT a long-term investment - in fact, it is a one-day trade (or at most, a few days). It appears that the investor must anticipate a
price spike, buy, and then sell immediately (within a few days at most), to make money."
Since their inception leveraged funds have certainly had their share of doubters. Michael Johnston of ETF Database provides an excellent myth-busting article to many of their points; yet even he only partially addresses the true issue of long-term price decay.
In this article I've set out to shed some light on the big bad boogie-man that is "leveraged fund decay" and walk through how to quantify, as closely as possible, what the actual cost is to hold these leveraged funds. Beat this cost, and the prospect of compounding long-term leveraged gains becomes attainable.
I'll look at 5 major asset classes and their 2x and 3x ETF alternatives, provided by the table below: