Study finds Leveraged ETFs Risky Even for Sophisticated Investors
Leveraged ETFs can pose an overall adverse effect on performance, according to a study from academics at Clemson University, Colorado State University, and University of Toledo. The study was first reported on by the Institutional Investor. The academics argue that “institutions in aggregate do not benefit from exposure to leveraged ETFs. Rather, these instruments appear to be used by institutions prone to poor market timing … confirming the difficulty in earning abnormal returns through market timing.” The study reviewed 6,467 institutions that manage over $100 million in long positions and found that the proportion of institutions holding leveraged ETFs grew from less than 1 percent in 2006 to 12 percent in 2011. Leveraged ETFs have distinct features in comparison with non-leveraged passively managed ETFs, the study’s authors write, although both products target a market index. For example, a 2X leveraged ETF based on the S&P 500 targets 2X the return on the S&P 500 for a holding period of one day. Leveraged ETFs frequently use futures, derivatives, and especially total return swaps to achieve the targeted return instead of traditional leverage. The study’s authors point out that leveraged ETFs can represent an especially risky investment in many portfolios and could prove costly for unsophisticated investors. In an interview with Institutional Investor the authors said if a particular institution holds certain leveraged ETFs, then the institution is likely to perform worse relative to its peers in the future. The paper explored the linkage between institutional equity performance and investment in leveraged ETFs over the period of 2006-2016 and found that leveraged ETF positions predict poorly performing institutional equity portfolios that could not be explained by institutional characteristics such as portfolio turnover or investment objectives. The study also found that institutions reduce leveraged ETF holdings following good performance (but do not increase leveraged ETF positions following poor performance). The authors say their study offers implications for academic research as well as for policy makers.