Capital Efficiency Takes A Step Forward?

The market for leveraged ETFs took an interesting turn today with the launch of 2x leveraged funds by Tradr that target weekly and monthly outcomes instead of the typical daily outcome. According to the prospectus that covers all of them, quarterly versions will be out on October 1st. 

My first thought is, if they work, I say IF they work, they are a path to democratizing do-it-yourself capital efficiency in a portfolio. While I am skeptical of the ReturnStacked funds, we've written a lot of posts going back a long time about using leveraged funds for capital efficiency, that is to say leverage, before I'd heard the term capital efficiency. 

I've said many times, going back a while, I've made the observation that holding 2x long S&P 500 has not been catastrophic. It's been pretty close far more often than not on a year to year basis. If you spend the time, I'm sure it would be easy to tease out periods where the difference between 1x and 2x was not pretty close. The 3x has not been that terrible year to year either. The worst year for 3x was either 2015 when the S&P 500 was up a little and the 3x was down 5% or it was 2020 when the S&P was up 18% and 3x was only up 9%. 

The longer term compounding is less favorable due, in all likelihood, to the leveraged funds having to dig out of some big holes after large declines. If the plain S&P 500 drops 3% one day and 3x drops 9% like it should, that can be a big hole to dig out of. And the depending on the sequence, that could compound into a very painful drag versus not using leverage.

The best example of a leveraged ETF catastrophe is probably with Microstrategy (MSTR) and a 3x long version that trades in London.

The common is up 207% this year and, as I mentioned the other day the 3x long is down 84%. To make one thing clear, this post is not that I think leveraged ETFs are the answer, more like an exploration to see if the this next evolutionary step with leveraged funds, the monthly and soon to be quarterly, could be useful. It's way to soon to know but I am curious to see if they can work out.

Playing around with how 2x Long SPY Monthly ETF (SPYM), or the 2x Long SPY Quarterly ETF when it lists, I think we can use SSO and be close.

The way I laid it out, Portfolio 1 is plain vanilla 60/40, Portfolio 2 tries to create an apples to apples comparison and Portfolio 3 is in line with what we usually blog about in terms of avoiding interest rates, using a couple of alts as well as a small position in client/personal holding BTAL.

There were no catastrophes with SSO but it doesn't always track perfectly of course and going forward there is no way to know if there could be a catastrophe or not. As a theory, I think there is a fulcrum point of volatility where the leveraged funds track less closely maxing out at the Microstrategy catastrophe we mentioned above.

The Tradr ETFs target, weekly, monthly and soon to be quarterly outcomes. Giving them the benefit of the doubt that they will do what they say they will do, I'm not sure what holders should expect it to look like mid week or mid month. If one month from now, you know that the S&P 500 will be 1.75% higher, I'm not sure you could know what path SPYM will take to gaining 3.5%, again I'm assuming it will work. 

Also, I am not certain, but I think the odds are pretty good that the reset at the end of the week, month or quarter could be much larger than the daily funds. The monthly fund resets on the last trading day of the calendar month. It might make sense to sell before the reset and then buy back in the next day (or after the reset has occurred). Being out of the market might for a day or maybe two might not be great but you could swap into a daily resetting fund for the day or an unlevered fund to avoid being completely out.

This all implies a lot of work and you'd find plenty of different takes on whether it's worth it. The strategy could work but the utility is in the eye of the end user and of course, this really wouldn't make sense in a taxable account. I am going to watch though to see this idea could "work."

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