However, in times of increased volatility, leveraged ETF returns can fall behindtheir intended 2x or 3x strategies. For instance, when including the period leading up to the financial crisis and the financial meltdown, SSO lagged the S&P 500.
“A 2x LETF doubles the average return while increasing volatility drag by a factor of 4; 3x triples the average return while increasing drag by a factor of 9; and so forth. That is, average return increases linearly, and drag increases exponentially. So as leverage increases, growing drag eventually overwhelms the levered return, resulting in lower compound returns,” according to Howard, Bunker and Stock.
For all the criticism they endure, well-heeled leveraged ETFs may not be as volatile some believe. [A Gentler View of Leveraged ETFs]
“What the researchers are saying is that money tends to move out of leveraged funds on the days the funds move up significantly—mostly due to profit-taking—and money flows in after down days. Such movement helps keep the asset base steady, thus reducing the fund’s need to rebalance its leveraged exposure in the direction of the market, which is what can contribute to volatility,” reports Ari Weinberg for the Wall Street Journal.
UWM vs. IWM Five-Year Chart
Chart Courtesy: StockCharts.com
Tom Lydon’s clients own shares of IWM.