Can Defined Volatility Solve Leveraged Fund Decay?

Leveraged strategies have long been the catnip of day traders, but what if a strategy allowed long-term investors to gain leveraged exposure to markets while still remaining responsive to market movement? Ben Fulton, CEO and President of WEBs Investments, explained how his firm seeks to solve for that very thing at Schwab IMPACT 2025 with ETF.com's Dave Nadig. The following is a full transcript of their conversation. 

Transcript

Nadig: Ben Fulton, I'm gonna have to smile while I say it, WEBs Investments. Before we get going, I felt like you named the firm thinking that you were going to talk to me, because my very first job in ETFs was working on the “WEB”s product for what is now iShares. How did you come up with the name and it must have been in your mind?

Fulton: Well, yeah actually, you know, 30 years into ETFs like yourself and I– one of my first projects, we were going to build a– it was a UIT of ETFs and it was with WEBs. And it’s actually still to this day the only time I’ve ever heard the SEC called on the day we were launching the product and said, "You can't launch this product." And it got mothballed with never an explanation. Lawyers never heard, it was just, "You can’t do this." 

But I think it was the idea of someone doing alchemy, creating– putting ETFs together in another wrapper and it was like, "We can’t do this." But I think today, as a room full of people that I could roll up this carpet and get a ticker for it, I get it.

Nadig: In all seriousness, let’s talk about what you’ve built. I feel like we’re in what I’m sort of thinking of as a leverage 2.0 age. A little bit like we fixed a lot of the dumb indexing, like we don't talk about the Dow very much, we figured out better ways to do it. It seems like you guys are taking that approach to sectors. Talk to me about what you’ve actually launched and then I’ll grill ya.

Fulton: Yeah, you know, if I look at it, my first theory or ethos was as I said, you know what, I think there may be enough ETFs out there, or most of them there's probably enough that covers. But not all ETFs, especially a lot of the big flagship benchmark type product, maybe the owner experience isn't always what people wanted. 

And you know, I spent a few years at ProShares and I was a little shocked how many people were long-term holders of leveraged ETFs and I went, “You know, that's not really a good idea.” ProShares wasn't advocating for it. It was just a case of what was going on and it made me start thinking through, that maybe there was an appropriate way. 

Was there a way we could identify times where leverage was probably acceptable, but then there's times where you actually want to reduce exposure and could we create that? So we spent a few years modeling out, figuring out, and created what now we call Defined Volatility.

Under the Hood of the WEBs Defined Volatility ETFs

Nadig: And so you pick a number, let's say 30%, for the volatility of a particular sector, say utilities. How do you come up with that target volatility right there?

Fulton: Great question. So the first two products were on SPY and QQQs. Those were the long-term 30-year standard deviation number annualized, so 20 and 22. With sectors, we did a little different. Because people are high conviction, we did the same 30-year test of the S&P sectors, but we took it at 120% of that historical level. So if the old level was 20, we rolled it up to 24, so we made it a 25. And then some were at 20 and some were at 30. 

They're a little more aggressive. We'll call 'em– we're based in Park City, Utah, so maybe we're a little over our skis on this one, but the idea is a person that makes an allocation or feels like this sector is what I want, we felt like they want a little more turbocharged.

Nadig: So let's talk about how this works in practice. If I buy the Target Volatility S&P 500, when the actual realized volatility of the S&P is lower than that, I'm levered, right? How often are you checking against that? How often are you looking at that?

Fulton: Every day. Okay, so every day we line up to the Street, to our counterparties. So we do use a swap. We both own the ETF– we own SPY or sectors, we own XLE, plus we have a swap, long-term 13-month swap, so it’s tax friendly for the wrapper. And what we do is every day look and we take the last one month’s volatility lined up against that long-term number, our North Star. If it's low– if it’s let’s say it’s 20 is our goal. If the volatility today is 20, we're a 1X fund. If tomorrow we wake up and volatility’s dropped to 10– that’d be a big move, but it drops to 10– we're a 2X fund.

Nadig: And so you're taking care of that in the sort of what we would think of as the normal nightly rebalance of a leveraged fund. So it's still daily levered in the sense that when you look at the fund and it says, "oh, I've got 1.7 exposure to the S&P," that's tomorrow, right? That's for the one day.

Fulton: That is tomorrow, right. But it's not a fixed number. So what it does is– I won't say it totally removes, but looking at 30 years of history with it, I can’t model out where I see the same decay problem that you have. Because the number is variable and it's variable with that. So you’re not rolling into the classic 2X and the market’s falling. What you tend to have is if a market's falling, you tend to have higher volatility, so we actually have less than 1X exposure. 

If anything, we lean out of the market during high risk periods and we only lean into the market during periods of peace or calm. So, you know, it's a– I like to say we take existing ETFs, we improve the suspension, and we up the horsepower. So that's what we do. It’s a little custom car, but you know, I think it makes sense. Now, ideally in the future, we would like to bring a more conservative version, maybe a more aggressive version. But we're working now with some modelers that will then take our sectors or others and do sector rotation because that would be perfect.

Nadig: That was my next question, right? Because that would allow you to create more of a vol-evened exposure if you were doing a sector rotation strategy. Which have been out of favor for a long time but make a lot of economic sense, right? I want to be in energy, I don’t want to be in tech, that kind of thing.

Fulton: You know, and it's interesting, we made a pretty big decision probably a year ago. We decided, "No, we're gonna come back out with sectors." Because I said, “Look, you've got a declining dollar, you’ve got some breakage.” I mean, we went through almost like a panacea for like 10 years where the dollar was the known global currency. Is it the known global currency? Maybe gold is, maybe that's why gold's at 4,000, I don't know. 

But sectors also, they decoupled and all of a sudden you go, "There’s sectors that are..." So I think the old classic Kudlow–I was at Bear Stearns in like the 80’s. Kudlow used to have the regular rolling recessions. We're back into rolling recessions. There are– we're gonna have something out. And in the meantime, AI's hotter than hot over here, but something else is gonna be going through. And then they'll roll back in and now, I think it’s gonna happen faster now than we've ever seen. It used to be we had 9, 12 months to figure it out. We might have 9, 12 days to figure it out.

More Asset Classes on the Horizon

Nadig: And a quarter if you're lucky. I have to ask– I'm almost reluctant to ask this question. We've seen a lot of product development in things like single stock leverage or microsector leverage, small collections of, you know, eight stocks on a micro theme. You could obviously apply this kind of math to any of those things. Are you looking at or would you consider doing a vol-controlled Palantir ETF? I mean, there's a lot of froth in that right now.

Fulton: You know, I will never say never, but I’m more intrigued with like, you know, what we're looking at it on bitcoin actually. Deleverage– put a target like historic volatility of Bitcoin's about 90, right? But maybe do a 30-vol: bitcoin actually makes it still incredible returns but it takes a lot of the wildness out of that ride. Maybe makes sense, for sure like a gold or GLD and some of those. 

We've done it with some single stock. I think my– I mean, actually if you ask me, I'm all for– I think product development is amoral. I'm not going to say something’s right or wrong, but I don't love single stock leverage. I think someone's going to– something bad's going to happen there someday. And so I look and go, “You know what, I don't think I want to populate it.” It’s a hot area to gather assets though, you know. So good for many friends of mine are having a lot of success and happy for 'em, so.

Nadig: A lot of people buyin' houses. People gotta get their kids through school, I get it. What about other asset classes though? You mentioned bitcoin, but you could also apply this to Treasuries, right? I mean, you could run an AGG version with a 30-vol target and you’d be what, three and a half levered or something like that. Where do you think about that as portfolio building blocks?

Fulton: Even some alternative indexes that we're looking at that are more institutional based. We’ve talked with some index providing firms that are doing some alt-slate that might be a super low-vol thing, and yet they tested just doing a regular levered version. But the problem is every once in a while their volatility spikes and it's like, "Well, we remedy that, we take that out." I know when our product works and when it doesn't. Most of the time it works great. It's been working great for the balance of this year, but the first quarter of this year, where it was unpredictable, chaotic volatility...

Nadig: Vol of vol was high, yeah.

Fulton: Yeah, we were– you know, we ended up delevering, so we were like 40% exposure and then all of a sudden tariffs get taken off and you get a 10% run. We're still at 40% exposure. So, you know, but I sit and I go–but if I could put people back in that timeframe at that moment and say, "You know what, we have 40% exposure today," I'd feel good– I feel good about that. 

I think most people would go, "You know what, I'm kind of glad you hit the off-ramp. You got me off the interstate. I don't know what’s going on. Let me do this. We can get back on and drive full speed or even drive faster when the time's right, but right now we don’t." So if we can keep people in the mindset to realize, "Remember during COVID we dropped down to 20% exposure. And sure the market might take [off] but we did what was right and in the long run you ended up having an outperformance." 

So, you know, we always say for the two flagships, the SPY and Qs, we like to see at least an 18-month investment time horizon. If someone's saying it’s now and I need the money in, you know, in six months, well you shouldn’t be in an ETF probably. 

Variable Leverage With Daily Transparency

Nadig: Well, this makes the point though, a lot of the leverage and inverse funds are really used by day traders. You're providing leverage in a way that’s designed not necessarily for day traders, right? So that makes sense. Obviously monitoring these products as a buyer or seller is really important. Tell investors where they can go to keep track of what's the vol factor on this ETF today.

Fulton: Yeah, so actually interestingly if you go to our website, you go to the product list. The product list doesn't just tell you where the current exposure is. If you hit on the name, it'll actually predict what’s going to happen at the close today based on what’s happening today based on the vol we’re seeing. It'll say, "here’s where we rebalanced last night,” 

So last night we had a big reduction, so I think we're down to about a 1X fund on Qs. And it was– but it probably dropped from 120 to 100, you know, don't hold me exact. But it's kind of interesting. So people will look at it and go, "Hey, they keep us up.” And then you'll start seeing it starting to relever back up. So it’s very– we try to be as transparent. Always call us. I mean, maybe there’s some things we could put out there more. We want people having full knowledge, understanding. It’s new science, but in some ways it’s not rocket science, you know?

Nadig: Yeah, I mean it's new from the sense that it's new in an ETF wrapper, but people have been messing with the issue of how much leverage is the right leverage for which asset class since we started talking about portable alpha back in the day, right? So it's been around a little bit. Ben, thanks so much for spending some time.

Fulton: Great seeing you.

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