In Defense Of Levered Equity ETFs

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In Defense Of Levered Equity ETFs

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In a recent article, Larry Swedroe argued that long-term investors should avoid all levered ETFs (he suggested throwing them “into the junk pile of Wall Street creations”). He based this conclusion on a 10-year ETF return sample ending in March 2017. It turns out that this is an unrepresentative sample for making such a sweeping statement. Other studies, based on longer time periods, come to the opposite conclusion.

The attractiveness of levered ETFs is driven by the expected return and leverage employed. If the expected return is low enough and leverage is high enough, investing in them makes little sense and can produce returns lower than the unlevered counterpart. However, if the reverse is true, they are powerful long-horizon wealth generators, particularly in equity markets.

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In a 2015 article, I, along with Lambert Bunker and David Stock, discussed the merits of long-term investing using levered-equity ETFs. We cited two carefully researched studies, which were based on return data for a number of equity markets over time periods extending as far back as 1885. They concluded most 2X- and 3X-equity market products came very close to achieving their stated goal over long time periods, even when daily compounding and typical ETF fees are considered.

In light of these more comprehensive studies, it appears that Swedroe’s rejection of equity levered equity ETFs is driven by a limited sample. His blanket recommendation should not be given serious consideration by advisors.

As a final comment, in another recent article I presented research and actual performance results demonstrating the successful long-term holding of levered equity ETFs in my firm’s global ETF strategy. We accomplished this by levering only when one of our behavioral market barometers flashed a strong enough measure of expected returns, making leverage attractive in that specific market at that time.

Beyond the academic research I cited earlier, I have shown, both through my research and actual performance, that it is possible to beneficially employ levered-equity ETFs for building long-horizon client wealth.

  1. Thomas Howard, PhD is professor emeritus at Daniels College of Business, University of Denver, CEO of AthenaInvest Advisors and Chief Investment Officer at AthenaInvest.

 

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