Don't Frown, Leverage Down

Let's start with this from Eric Balchunas.

The existence and use of leverage isn't what does people in so much as the misuse of leverage. There is of course a lot of complexity to leveraged funds and in addition to misusing these funds, I think people can run into trouble not fully understanding what they're getting into. 

There is a cost to the leverage in these funds. There are different ways to observe the drag/cost of the leverage, you can see a difference between the target and the underlying when looked at over longer periods. There is the issue of understanding the daily (usually) reset and the compounding of the reset that can cause a levered fund to diverge meaningfully from its intended objective over longer periods. The boiler plate is always clear about how to use these but still.

Tesla is much more volatile than Netflix which impacts the 2x levered funds of each. NFXL, the 2x Netflix, since it's inception is kind of close to the underlying. The common is up 75% and the 2x is up 146%. The difference could be thought of as a cost of doing business. The 2x Tesla is a whole different story. The common up 79% and the 2x up less than that. 

Here's the month by month breakdown;

The point here is to understand the product. There are drawbacks and they probably outnumber the positives but I think it is worth continuing to explore. Using leverage the right way, leveraging down, can work. 

The 30/70 portfolio uses a little leverage but I wouldn't say it leverages up.

ROM is 2x technology so while 30% is allocated to equity funds, the exposure is 45%. GLIFX which we looked at yesterday owns equities but I think it is alt-ish. MERIX and CBOE are client and personal holdings. The equity mix is higher beta which is another form of leverage embedded in the 30/70 so it is really 45/65 and 5% gold. 

TSLL is not 2x Tesla, NFXL is not 2x Netflix and ROM is not 2x XLK. Framing them the way have started to do over the last couple of months, they are each the underlying reference security plus the volatility of the underlying reference security. Unlike derivative income funds which sell that volatility, the 2x funds buy the volatility. With TSLL, the long volatility has hurt returns. With NFXL it appears to have enhanced returns, same with ROM. 

So 45/65 and 5% gold is actually 45% equity/long volatility, with 65% in fixed income and fixed income proxies and 5% gold. 

The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.