While most traders and investors seem to be aware of the effects of decay and compounding with leveraged ETFs over multi-day periods, few likely understand how they might work over multi-year horizons. Most of the 3x ETFs have been around for about just a year, and nearly all 2x ETFs never experienced the entire previous bull market. In the interest of attempting to understand the long term characteristics of leveraged ETFs, it is possible to simulate their performance over long time horizons by using non leveraged ETFs that track similar indexes as their leveraged counterpart.
Today’s post will demonstrate the estimated and hypothetical performance of several popular 2x and 3x leveraged ETFs during the course of the 2004 to 2007 market. To make it a bit easier to visualize their performance, the daily returns from the historical period have been added to the last day of 2009. (The first days of 2010 have been ignored). In other words, if leveraged ETF XXX is at 10.0 at the end of 2009, and the simulated performance for the year of 2004 was 10%, the chart will show XXX at 11.0 at the end of 2010. If history were to repeat itself and we have a bull market similar to the 2004-2007 period, perhaps some of these leveraged ETFs might have similar performance characteristics as these charts.
Generally speaking, the bull leveraged ETFs clearly succeed when volatility is low and the underlying index achieves significant gains. Even though ERX tracks a relatively volatile index (compared to the S&P 500), the index’s gains were so significant that ERX would have likely experienced significant gains during the last bull market. Alternately, ERY suffers from both significant decay and also decline due to being the inverse of a bullish index. Although these charts put leveraged bull ETFs in a good light, these results are only hypothetical, and future posts on this topic will show the losses (or gains) leveraged ETFs can experience in other scenarios.
If you like these simulations, you can see similar simulations (as well as more data) using QLeverageSim, which is a free utility for helping traders and investors understand the characteristics of leveraged ETFs.
Disclaimer: The results described in this post are purely hypothetical and are not an indication or guarantee of any index’s or leveraged ETF’s future performance. The leveraged ETF simulations are using data from ETFs that track similar but not the same index (such as using XLF data for FAS’s simulation). The resulting simulation data is thus inherently faulty since the leveraged ETFs track different indexes. The simulation results also do not account for fees and other costs.