Leveraged ETFs: Do They Really Decay?

Leveraged ETFs (LETFs) are financial instruments designed to amplify the daily returns of an underlying index, typically by a factor of two or three. They have received criticism for performance drag or value erosion over time. Despite these concerns, they continue to attract attention and capital from investors.

A recent trend in the literature has been to revisit the merits of LETFs. We have discussed some of these findings in previous editions. Reference [1] continues this line of research, examining the claim that LETFs deviate from and lose value over time relative to their non-reset counterparts. The authors pointed out,

We compare LETF returns over time to n times the underlying index return for the same holding period (after properly accounting for the necessary financing cost required to lever those index returns), which we call the “non-reset portfolio” in this paper. This is the natural comparison for us to evaluate the concerns raised by Cheng and Madhavan (2009) and the SEC (2009).

Simulations show that as long as volatility is not too high, LETFs generally have very high correlations to their non-reset portfolios, except for the 252-day holding period for the most volatile indices. When the underlying index volatility is very high (e.g., the EAFE, high volatility case, which has a daily volatility of 4.56% and annual volatility of 72.4%), our findings indicate LETFs continue to correlate with their non-reset portfolio closely if the holding period is not too long (i.e., 21 days) or the leverage ratio is not too high (i.e., 2x). However, as we emphasized, such high volatility has not been observed across all the considered indices in the past 20+ years. We also notice that when an LETF does not track its non-reset portfolio very closely, the LETF tends to outperform, and LETF and non-reset portfolio differences tend to be highly positively skewed: sizable LETF underperformance is less likely than same-sized outperformance in the samples and simulations we observed.

Overall, the value of LETFs does not erode in the long run. The concern that they do not correlate closely with the non-reset portfolio over time is not supported by the facts.

In short, the authors refute earlier studies suggesting that LETFs inherently suffer from value erosion. Their analysis shows that LETFs’ multi-day returns generally track closely with those of equivalent non-reset portfolios across most indices and holding periods (up to one year). While substantial deviations can occur under high volatility and extended holding periods, these deviations tend to be positively skewed and generally favorable.

Let us know what you think in the comments below.

References

[1] Wang, Baolian, Multi-day Return Properties of Leveraged Index ETFs (2025). https://ssrn.com/abstract=5119860