A portfolio of leveraged exchange traded funds

Abstract

This study demonstrates how a portfolio of leveraged exchange traded funds (LETFs) targeting a unit exposure to their underlying indexes outperforms a portfolio using traditional ETFs while simultaneously reducing downside risk. By extension, a 3x LETF portfolio designed to mimic 2x LETFs outperforms the underlying 2x LETF portfolio. The results are primarily a function of LETFs borrowing short while the investor lends the additional wealth generated from this leverage in one- to seven-year Treasury bonds or similar type of assets. For every one percent earned above the implied borrowing rate, a portfolio of 2x and 3x LETFs outperforms a traditional portfolio by 0.41% and 0.63%, respectively, corresponding roughly to the additional return on the 50% and 67% of the wealth invested in bonds. More than 90% of LETFs outperformance is explained by the borrowing lending differential.