Is Leverage A Form Of Insanity, Doomed To Fail?

There's been a fair bit of ETF innovation lately both listings and filings.

First up are single issue treasury ETFs from F/m Investments. So far they listed the US Treasury 10 Year ETF (UTEN), US Treasury 2 Year ETF (UTWO) and the US Treasury 3 Month Bill ETF (TBIL). Love the symbol UTWO. Here's a primer from Barron's but basically the funds will always own the current issue and then roll to the new one when it is auctioned. UTEN then will always have the most current ten year note, the so called on the run issue. 

When I first saw these I misunderstood, I thought the locked in ten years so that if you think the current yield for ten years is attractive, you'd be locking that in. That's incorrect. They certainly allow for precision in portfolio construction but I don't think UTEN or UTWO will gain a lot of traction with retail sized account. TBIL might be most useful for that market. If UTEN and UTWO find a use case, I would imagine it would be large, institutional pools of capital.

Sticking with single issue ETFs, Roundhill filed for a couple of single stock ETFs that each track a foreign stock, one is Saudi Aramco and the other Samsung, for which there is no sponsored ADR under the brand name Trax. I like the idea of theses. Foreign companies often come and go as far as maintaining their ADRs. Marine Harvest is a good example. At one point it traded on the NYSE, I've seen it trade as an unsponsored ADR a couple of times as it does now having changed its name to Mowi. 

Getting accurate quotes for unsponsored ADRs or ordinary shares can be difficult and those markets tend to not be deep. Orders for these types of stocks can be called in but that all adds up to being difficult versus these TRAX ETFs which do all of that work for you. Yes you'll pay for that in the fee, that's either worth it to you or it isn't. Over the years, I've used a couple of unsponsored ADRs or foreign ords in client accounts so I am not dissuaded by these ADRs if they proliferate, owning them the old way involved a little extra hand holding to make sure things like dividends were processed correctly. There's about a half dozen of these I have been following over the years and I'd be interested in adding a Trax version of one of two of them if those ever came to market. 

Since the buzz about the early listing for leveraged long and inverse single stock ETFs continues to build, I wanted to check in on them again. If someone says they are tools for speculation, mostly yes, that is how they will be used. If someone says the daily reset is a big risk that could blow up longer term holders, yes, that is absolutely possible. 

They do not have to be used to leverage up to buy more stock though. This is a point I've made a couple of times before and will continue to make, they can be used to leverage down providing capital efficiency and/or technically exposing fewer of your dollars to risk assets. For this post let's look at client holding Nike (NKE) and the AXS 2X NKE Bull ETF (NKEL). Instead of $10,000 into NKE, an investor could put $5000 into NKEL and put the other $5000 into TBIL or something like $4000 into TBIL and the other $1000 into something with a negative correlation to the broad market or something that was reliably, negatively correlated to NKE. Here's NKEL compared to NKE since it's inception.

 

For some reason, the chart doesn't have NKE's trading on Friday. On 8/12 it closed at $116.07. So in the period that NKEL wsa up 27.5%, NKE itself was up 12.44%. So not an exact doubling up and it is only one month but is that close enough? Of course there is no way to know the future sequence of daily returns of NKE and by extension NKEL but a point I've been making for a few years is that the 2x funds kind of "work" over the longer term. I've observed far more variance in the 3X funds, but 2X often look like the above chart which is to say not that far off. 

Doing something like this with an individual stock is very unlikely to ever be my trade but it is short sighted to assume leverage on its face must be bad. Many people misuse leverage and yeah, that is a catastrophe waiting to happen. There are ways to use leverage prudently though, we've gone over several example here in the last couple of months. This is something to study and learn from to possibly be part of the solution down the road. 

Generally, instead of naysaying, I would rather take an extra minute to figure out whether and how something new might fit in with how I manage portfolios. Not everything will find a home in client accounts, but every so often it does make sense to add something to the toolbox.