Abstract
Leveraged Exchange Traded Funds (ETFs) (LETFs) are a recent and highly successful financial innovation; yet, investors and several studies criticized them for not performing as advertised, especially in the long term. Τhis paper discusses their unique characteristics and their path-dependent price dynamics, which may result in unexpected returns. Furthermore, the authors evaluate the performance of a large sample of European and American leveraged ETFs since each fund’s inception and show that they perform as intended for daily holding periods. Leveraged ETFs are also successful in delivering the promised performance over holding periods of up to one week, their performance starts to deviate when the holding period increases to one month. Empirical evidence suggests that bear (short) ETFs deviate from their target return more quickly than their bull (long) counterparts as the holding period lengthens. A possible explanation for this is that transaction costs, which are related to daily re-balancing activity, are higher for bear funds. When comparing the daily performance of European vs American funds, the authors find them both to be equally efficient in replicating their benchmarks, although European leveraged ETFs are much smaller in their Assets Under Management (AUM) compared to US LETFs.
Highlights
Leveraged Exchange Traded Funds (ETFs) use derivatives and debt to provide a steady multiple of the returns of their underlying indexes by maintaining a daily stable position of leverage and since their inception, LETFs have been drawing ever increasing considerable interest from investors and traders
When comparing the daily performance of European vs American funds, the authors find them both to be efficient in replicating their benchmarks, European leveraged ETFs are much smaller in their Assets Under Management (AUM) compared to US LETFs
ETFs are one of the most successful innovations of the past two decades in financial markets globally. Their introduction was not controversial until the introduction of leveraged ETFs in 2006; unlike traditional ETFs, LETFs have leverage embedded as part of their design and are preferably used by shortterm traders
Summary
Leveraged ETFs use derivatives and debt to provide a steady multiple of the returns of their underlying indexes by maintaining a daily stable position of leverage and since their inception, LETFs have been drawing ever increasing considerable interest from investors and traders. A fund can obtain a return, which is 2 or 3 times higher that of the underlying index by using leverage to invest in enough stocks or other derivatives. When leveraged ETFs were introduced in the US market in 20063, they were largely misunderstood and misused in portfolios, resulting in unexpected returns and important losses Their performance in the long term is not n times the performance of the underlying index, but may be considerably lower or even higher, relying on the behavior of the underlying index. This is the first study to compare European LETFs with their American counterparts
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