Leveraged ETFs for the long term play is a trap for the math illiterate
Put two and two together a) they guaranteed you leveraged return on a daily basis only, b) you need always a bit higher return to recover from the loss, e.g to recover from -1% loss you need +1.01% and this only gets compounded by leverage
Can work both ways. SP500 went from 880 to 3170 from 10.07.2009-today. So a 3.6x increase.
UPRO went from 2.09$ to 47.60$ in the same time, so 22.8x increase. That’s a 6.3 times higher return.
At least one issue is that UPRO+TSM has a huge home bias for US folks, so if you’re not in the US that could be an issue.
I personally find risk parity super interesting, unfortunately there are currently no cheap way of implementing it (I wonder when cheap risk parity ETF will be a thing).
I’m also not 100% convinced that using leveraged ETF are actually the same thing as proper risk parity, I also have still not seen anyone explaining how risk parity is supposed to work with negative risk free rates (leveraging negative yielding bonds seems like a really bad idea).
Also I had the impression that risk parity fund didn’t do so well during the high volatility period back in March. (Might be because of the increasedb correlation between bond and stock?)
If you explain you’re doing risk parity, I don’t think it would be an issue, you’re not like daily trading, just trying to get a better risk adjusted return.
Hi,
I’m looking to apply some leverage in my portfolio. I read recently life cylce investing and i found the idea and the results (they provide backtests in the book) really interesting.
after applying a discounted cash flow to my personal situation, i realize that i’m actually in a 85/15 allocation. despite being 100% in stock and having my 3rd pillar 100% in stock. so if i want to be diversified in time i better start applying leverage.
I have put a small portion of my portfolio in HFEA (55/45 UPRO/TMF). and i would like to have a 60/40 x2 leveraged portfolio. even a 40/60 (stock/bond) beats the SP500 with x2 leverage. backtest
40/60 x2 has 11.4 standard deviation, and 60/40 x2 13.8%, vs SP500 14.6%. so you get better CARG and better sharpe with a leveraged conservative portfolio.
once i get close to my f*ck you number, i would probably go for a SWAN strategy, this is 90% secure assets, like long and mid term bonds, with 10% leveraged on SP500.
i need to call my canton to discuss if this is considered professional trading. it’s always a grey area for me.
You sure you want to do this?
In one of the reviews someone wrote „The 75/25 strategy and their approach had the same average wealth at end of life“.
75/25 is my approach shortly before FIRE. Before I‘m happy with 85/15 (The 15% mainly second pillar and some emergency fund money)
I was more thinking about S&P500 mini futures MES. One lot is x5 S&P500, so around 24k USD now. And there are no dividends.
And I bought one, but it was 23k.
I always thought ES futures would be very interesting as a Swiss investor since you avoid dividend tax drag too.
Downside, you play implied financing cost (and can’t really park USD anywhere for similar rate) and maybe some small tracking error. If you want to leverage portfolio anyway then can be great.
How do mini futures work? Do they need margin?
Wouldn’t you take on an US bias and what would be the duration?
I am not really bullish on the Us as a region going forward. 
Warning to everyone: always check lot size for futures or it is very easily to get screwed (or FIRE prematurely). ES futures are S&P500 x50, i.e. one lot 230k USD. I bought MES which are x5.
Yes, it is written on the page of the instrument. For MES it is around 2k USD per contract. What is nice, as far as I know, collateral cash could be in any currency, so you can just deposit 2k CHF and avoid currency fluctuations.
I increase US exposure at IB and recalculate my other holdings (finpension) to get to ACWI geographic weights in the whole portfolio.
Market rate, i.e. less than margin loan rates.
Yes but your margin requirements are like 5%. So you are paying implied financing on 100% of the notional and then if not leveraging need to park 95% of the cash somewhere else.
Where would you park the 95% of your remaining cash? IBKR pays nothing, US treasuries/cash pays very little and yield is subject to income tax, etc.
Other challenges I found included:
Bit more.
I am leveraging.
There are Euro Stoxx 50 and Nikkei and even SMI (!) if you want. But I don’t.
One of the lowest. Only SMI micro is smaller. And it is called micro actually.
Why do you think I have “entire portfolio exposed through derivatives”?
I am increasing total portfolio size without paying it 100% in cash. And yes, leverage comes with interest, but you have to convince me with numbers that it is not cheaper than alternatives.
I could have bought European futures and replace part of the exposure to European stocks by futures, but I prefer MES. Doesn’t matter, I can calculate how to bring portfolio to a geographically correct weighting.
My comments aren’t with regards to your full strategy, just the challenges I found when looking at index fund futures for tax efficiency + equity leverage in Switzerland.
But if you’ve found good solutions to them I would be interested to hear.
MES are currently $1.15k maintenance margin on $23.4k notional = ~5%.
Even if you are leveraging 2:1 you have a big chunk of extra cash to park somewhere.
Once you start looking at volume and ticket sizes it becomes very hard to use to a desired weighting in a portfolio.
So what is your overall portfolio? Something like 90% equities and then 110% in MES using the 10% cash buffer?
So from a slightly newbie perspective you are using Mini-Futures to achieve leverage on the US part of your portfolio?!
I assume this is slightly cheaper than leveraged ETFs?!
But would both have the same outcome? It seems leveraged ETFs are slightly more hands-off but with higher cost, no?
Not worrying about margin would be something important to me.
There are different numbers and they are changing. Yesterday the overnight margin was like 2.1k USD I think, today it could be lower because the volatility went down.
I don’t understand. I use cash as a collateral and a cushion in case of the value decrease. Other cash is in other places. I can add more from my ongoing savings, in worst case it will be a margin loan.
Stocks: 150+ k in US ETFs at IB, 60+k in stocks index funds at finpension + some other funds. I am investing almost everything that is left at the end of the month. One MES is less than 10% on top of amount invested in stock funds.
My wife is accumulating cash, so I don’t know exactly how much is there. With our 2nd pillars we are below 50% in stocks.
Yes, and by extension on the whole portfolio.
Probably.
No. Leveraged ETFs use derivatives to keep a constant leverage rate. So if index goes up, they buy with gains more futures, for example, and if index goes down, they have to sell futures to decrease the leverage. At least that is my understanding, and I don’t know another way to keep leverage constant. So kind of counterproductive, and no surprise that in the long term you lose.
Future has a fixed lot size, like 5x SPX. If index goes up, you receive cash, if it goes down, you are losing cash, but the market value remains fixed. If market moves against you, you can add more cash to compensate losses, but you are not losing “overproportionally”.
Let’s say SPX is at 4000, it first moves up 500 points, then down 500 points.
With a 5x future you are almost at 0 difference, first getting 2500, then losing 2500 (there are implicit financing costs and accounting for dividends, but let’s ignore it for now).
With a 3x leveraged ETF and a starting value 20000 you first win 3*(500/4000)20000 = 7500. Now the value of your stake is 27500 and the leverage went down. The fund is buying more futures to be 3x leveraged again. Then you lose 3(500/4500)*27500= 9166. You have lost 1666.
If you are using IBKR then their risk algos will set margin higher yes true. I see right now it is ~2k / ~9% overnight margin.
And ok if you are just leveraging 1.1x then this works well - I agree the cheapest leverage you will get.
My struggle in the past was trying to get full exposure through index futures to avoid dividend tax drag.
I was thinking about it and decided not to do. The main reason for me was that actually if you throw away dividends from the very beginning, you can’t reinvest them. And this is where magic happens, the long term portfolio growth is not due to the price increase, but due to the compounding effect.
Index futures aren’t throwing away the dividends, expected dividends are accounted for in the price (amongst financing costs etc.).
https://www.cmegroup.com/trading/equity-index/report-a-cost-comparison-of-futures-and-etfs.html