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A tracking error approach to leveraged ETFs: Are they really that bad?

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  • Bansal, Vipul K.
  • Marshall, John F.

Abstract

Exchange traded funds or ETFs are undoubtedly one of the most successful financial innovations of the past two decades. They were largely noncontroversial until the advent of leveraged exchange traded funds or LETFs which were introduced in 2006. LETFs have been criticized by many in the popular press, but also in a number of scholarly journals, as routinely underperforming their stated return objectives. They have also become the subject of many lawsuits. Noticeably few scholarly papers have defended them. We take a tracking error approach, using both simulation analysis and past historical data, to examine how these funds would have behaved under various return/volatility scenarios. We conclude that LETFs of the 2×, 3×, −2×, and −3× varieties have been wrongly maligned and we believe they should be considered for inclusion in aggressive portfolios.

Suggested Citation

  • Bansal, Vipul K. & Marshall, John F., 2015. "A tracking error approach to leveraged ETFs: Are they really that bad?," Global Finance Journal, Elsevier, vol. 26(C), pages 47-63.
    • Handle: RePEc:eee:glofin:v:26:y:2015:i:c:p:47-63
    DOI: 10.1016/j.gfj.2015.01.004
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    References listed on IDEAS

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    1. J.Swaminathan & A.Ananth, 2011. "Impact of Mutual Fund Investments in Indian Equity Market," Indian Journal of Commerce and Management Studies, Educational Research Multimedia & Publications,India, vol. 2(2), pages 228-238, March.
    2. Guido Giese, 2010. "On the risk-return profile of leveraged and inverse ETFs," Journal of Asset Management, Palgrave Macmillan, vol. 11(4), pages 219-228, October.
    3. Charupat, Narat & Miu, Peter, 2011. "The pricing and performance of leveraged exchange-traded funds," Journal of Banking & Finance, Elsevier, vol. 35(4), pages 966-977, April.
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    Cited by:

    1. Bansal, Vipul K. & Marshall, John F., 2015. "Tracking error decomposition and return attribution for leveraged exchange traded funds," Global Finance Journal, Elsevier, vol. 28(C), pages 84-94.
    2. Yuan, Ying & Huang, Yizhao & Chen, Haoran, 2021. "Monthly-rebalanced leveraged exchange-traded products: Performance and mandatory rebalancing needs," The North American Journal of Economics and Finance, Elsevier, vol. 57(C).

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    More about this item

    Keywords

    Exchange traded funds; Leveraged exchange traded funds; Tracking error; Constant leverage trap; Dynamic rebalancing;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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