As you can see, the U.S. 20+ year Treasurys have been deviating from their target returns by much larger percentages of returns than their equity counterparts.
For example, the single-exposure ProShares Short 20+ Treasury ETF (NYSEArca: TBF) returned -4.40 percent in the six-month period, whereas a simple multiple of the benchmark return was 0.40 percent.
That’s a difference of “just” 4.80 percent, but on a relative basis, it’s enormous.
This performance is quite different from a year ago, when equities were volatile and bonds more stable. In this case, fixed-income levered ETFs were less likely to burn investors when held over the long run. In fact, you can see that the Treasury ETFs did better than the naive multiple would suggest over the time period studied. The ProShares Ultra 20+ Year Treasury ETF (NYSEArca: UBT) returned 74.20 percent, while the underlying index returned 33.21 percent (which would suggest a 66.43 percent simple multiple). That shows how compounding can actually help leveraged and inverse funds in trending markets.
What gives? Well, Treasury markets have become much more volatile over the past few months, while the S&P 500 has become less volatile. The daily price volatility of the 20-year Treasury index from April to October 2011 was 22.19 percent, while the daily price volatility of the S&P 500 was 26.38 percent. But from October through today, the volatility of the 20-year Treasury has been 18.41 percent—greater than the 18.02 percent volatility of the S&P 500. For the last three months, this difference is even more apparent. For the last 90 trading days, volatility for 20-year Treasury bonds was 16.74 percent compared to S&P 500’s 12.48 percent.
Holding levered and inverse funds long term without rebalancing is only safe in low-volatility and trending markets, and only if you monitor the funds on a daily basis. But in those situations, it can work.
Importantly, however, you can’t count on any particular asset class to act in any particular way: Just as you can’t count on Treasurys to always be “safe,” similarly, you can’t count on stocks always to be risky. What holds true today may not be true tomorrow, which makes timing and careful monitoring more important with inverse and leveraged products than with others, because of the effects of compounding returns. The longer investors hold on to one-day products, the more room they create for uncertainty and volatility to creep in.
Still, the next time someone labels these investment vehicles as “evil” or say they can never be held for long periods of time—know that levered and inverse ETFs were probably not being monitored, or were otherwise being used incorrectly.
These products don’t behave erratically—it’s just that their long-term performance is predictable only as far as the market is unpredictable.