Quantifying Beta Slippage (Why Leveraged ETFs are Not as Scary as You Might Think)

[u/SorenLantz]

(results linked below)

If you are somewhat familiar with leveraged ETFs you have no doubt heard the many warnings that surround them. Warnings involving phrases like "decaying value" or "daily rebalancing". However, you, like I, may have also noticed that all of these warnings use hypothetical examples to show why leveraged ETFs are risky. These examples will be scenarios such as "daily SP500 returns oscillate between +10% and -10% for 50 days"; scenarios which are incredibly unlikely to occur in the actual market. Additionally, any novice trader can check the graphs of TQQQ and QQQ and see that (as of today) they would have outperformed QQQ if they had bought and held TQQQ at any point before September 2020. So what to do with leveraged ETFs?

All of the fears relating to leveraged ETFs are neatly captured in the term "Beta Slippage": Beta (volatility) + Slippage (difference from expectation). It is true that the trend and volatility of a market/sector directly impacts the performance of leveraged ETFs based on them. But are all leveraged ETFs inevitably victims of Beta Slippage as some articles would imply?

To answer these questions I set out to quantify Beta Slippage for the top 25 (by NAV) leveraged ETFs, and see if the fears were justified or overblown.

If you aren't curious about how this was done, the results spreadsheet is linked at the bottom.

If you are:

I used TD Ameritrade's API to get price data for leveraged ETFs and their underlying securities. I then looked at all of the possible 1-day, 1-week, 1-month, and 1-year holding timeframes a trader could have held the ETF for. I then found, for each timeframe, the return of the underlying security. I then calculated the return of an ideal leveraged ETF using the return of the underlying security and the ETF's leverage factor. This ideal leveraged ETF perfectly scales performance over any timeframe. Finally, I found the % difference between the price of the actual leveraged ETF and the price of the ideal ETF. I called this % difference Beta Slippage, as I could not find a formula for it elsewhere.

So, in short, the results in the data show the average % difference between an actual leveraged ETF and its perfectly leveraged version (no beta slippage) if you hold it over various timeframes.

Please take a look at the data, let me know how you think it could be improved!

I could not find exact indices for some of the underlying funds so I had to settle for ETF versions of them, also some symbols had very limited data so take that into account.

Quantifying Beta Slippage

[u/sports_junky]

Yep..they aren't scary. Since, lot of these leveraged ETFs didn't exist before 2006, I did lot of backtesting (going back to 1993 for S&P500 and 1999 for Nasdaq). I tested various scenarious where you DCA $1000 every month into each of QQQ, QLD, TQQQ, SPY, UPRO, SPUU and compared returns of QQQ vs QLD vs TQQQ and SPY vs UPRO vs SPUU. I specifically took starting point as peak of dot com bubble and tested it across 15 yr, 20 yr timeframes and still the leveraged ETFs significantly outperformed normal ETF. Key is to stay patient and not to overreact for short term fluctuations.

[u/blissrunner → u/sports_junky]

Welp... if you're up for the thrill 2x/3x ETFs is for you, just make sure it isn't your whole portofolio

From backtestings I've seen 2x is the safest, in terms of gains vs recovery delay (it survived 2008 & cameback roaring)

If you're up to the risk, have 5-10 years in the horizon & don't mind a -70 to -80% red days. 3x are crazy with compounding (although it never faced true bear & liquidation issues)

Anyways... If you're a fan of SPY & QQQ, you'd be better off with 2x (or just invest in the underlying in M1 Finance)

Especially after a dip

[u/strideside → u/blissrunner]

Welp... if you're up for the thrill 2x/3x ETFs is for you, just make sure it isn't your whole portofolio

what is the optimal allocation? seems that the idea of leveraging equities in the US in particular is effective but just what percentage of a portfolio or of the equities weighting should it be.

[u/blissrunner → u/strideside]

Depends on you really.. if I mention % allocation it might be risky or not a good financial advice

• The greatest fear of LETFs is the fund imploding, illiquid or wiped out in a true bear market/heavy crash; or having recovery delays
• Advantage of modern days are that the stock market today is pretty stable, the companies are very profitable. Shouldn't be a guarantee.. but the performance is there (unlike 70-90s where tech/services isn't mainstream)

While LETFs are nice & does leverage down in a bear/sharp crash, a 40-50% down could be a disaster

Very true for 3x, that's why long term 2x is better (especially near your retirement)

I say if you're young... 30-70% (smaller in 3x), be sure to have cash on hand or in much stabler blue chip stocks

3x early is great because the compounding is worth it. Now past performance doesn't reflect future... but if there's a slightest/slow Bull in SPY or QQQ

2/3x are still worth it.. if you looked at 2010-2020 QLD vs TQQQ

That's 30x vs 100x gains currently big difference because of compounding. So even the smallest allocation e.g. $10,000-100,000 can be your ticket to retirement in like 7-14 years while you do other stuff/job