A Leveraged ETF Investor’s Checklist

December 09, 2014

Clearly, getting the direction right mattered most in November, as it does most of the time. But the strong trend provides subtext of relative outperformance versus expectations.

In September, oil’s performance was choppy with no strong trends. Geared funds—both short and long, suffer in this environment.

Oil was down slightly in September at 0.96 percent, so you’d expect about a 3 percent return for the tripe-exposure bearish fund. Instead the “-3x” DWTI barely broke even at 0.4 percent, while the triple-exposure long UWTI fund did even worse than expected at -4.1 percent.

Sept_DWTI_UWTI

To recap, in November, getting the direction right was crucial. In September, the nature of the actual path of daily returns played a larger role. The pattern of returns can even overwhelm the directional call. By that I mean an inverse fund can still lose money even if the underlying index is down in choppy markets, assuming the investor does not rebalance exposure.

Path Dependency At The North Pole

A hypothetical example, one in the spirit of the season, also demonstrates the impact of the strong trends versus choppy returns on geared performance.

Imagine two elves, each making big bets against their favorite commodities—sugarplums and gingerbread—in the two weeks before Christmas using bearish triple-exposure ETFs. After the two weeks have elapsed, each bet has been proved right in both direction and timing: Each commodity has dropped, let’s say, by exactly 10 percent.

 

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