We have discussed the first reason why levered index ETFs fail to deliver in the long term. Now the second reason:
The Long Term Return Skew
What does "long term return skew" mean? It means over time, the distribution of the returns of the leveraged index ETFs are not normally distributed, instead, it will be skewed by a few positive outliers.
Let's use an example to illustrate: if an index has an equal chance of 10% or -10% returns per period, after 2 periods, there will be three compound outcomes: 21%, -1% (twice), and -19%. The average of these four returns is 0%.
However, only 1 return of the 4 returns exceed this average: 21%. Therefore, below average returns are increasingly likely for a leveraged ETF in a long term market.
Monte Carlo simulations supported this conclusion too.
In the end, a leveraged index ETF will deliver less than its expected return to a long term buy and hold investor in an up-swing market, but the risk (measured by standard distribution) is amplified (same as the multiples of the leverage).
Do you want to take on more risk but receive less return?
The Long Term Return Skew
What does "long term return skew" mean? It means over time, the distribution of the returns of the leveraged index ETFs are not normally distributed, instead, it will be skewed by a few positive outliers.
Let's use an example to illustrate: if an index has an equal chance of 10% or -10% returns per period, after 2 periods, there will be three compound outcomes: 21%, -1% (twice), and -19%. The average of these four returns is 0%.
However, only 1 return of the 4 returns exceed this average: 21%. Therefore, below average returns are increasingly likely for a leveraged ETF in a long term market.
Monte Carlo simulations supported this conclusion too.
In the end, a leveraged index ETF will deliver less than its expected return to a long term buy and hold investor in an up-swing market, but the risk (measured by standard distribution) is amplified (same as the multiples of the leverage).
Do you want to take on more risk but receive less return?
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