This is the third and last part, here is the links for the two previous parts:
The long-term return outperforms only slightly the S&P 500 Price Return (without reinvested dividends).
In the following graph, we compare the S&P 500 Total Return (with gross dividends reinvested) and the reconstructed CL2 between 1988 and 2024.
We observe that once again, the CL2 outperforms the S&P 500 Total Return over the period. However, the volatility is significantly higher in the case of the LETF.
We can also compare the performance between 1988 and 2024 of a Dollar-Cost Averaging (DCA) strategy in CL2 and a DCA strategy in an index that replicates the S&P 500 Total Return. On the y-axis, we have the multiplicative value. For example, if one had invested €10 per month since 1988, the total would be €10,000 in 2015 (i.e., 1,000 times €10), or €100,000 if one had invested €100 per month (€100 × 1,000).
In the end, the CL2 has not been very good; it is much more volatile than the S&P 500 Total Return and underperforms it for many years. This raises the question of whether there might be a smarter way to invest than simply putting money into CL2 alone. The next section will explore this possibility.
Summary of the CL2 model
In conclusion, we were able to model the CL2 return over the period 1928-2024. However, the assumptions made for the dates prior to 1999 are not reliable, so this period is only indicative. The period from 1999-2024 is much more reliable, and the model can be trusted with greater confidence.
The first observation is that over the long term CL2 has not been catastrophic and did not drop to zero. Therefore, leveraged ETF makes a conceivable option in a long-term investment strategy. However, we observe that the performance of the CL2 is close to, or worse than, the S&P 500 total return, with significantly higher volatility. This raises the question of whether buying CL2 is a worthwhile strategy for the long term. In the following section, we will explore some initial thoughts on a strategy involving CL2.
Dollar Cost Average (DCA) strategy with a LETF
This is not investment advice. The information provided here is neither a recommendation nor an offer to buy or sell any securities or to adopt any particular strategy.
After estimating the performance of Amundi's LETF CL2 back to 1928, we can consider a Dollar-Cost Averaging (DCA) strategy using such an ETF.
We have observed that when interest rates are high, the performance of the CL2 is diminished. This observation leads to the following thought: Why not invest in a LETF when interest rates are low?
The idea is straightforward: if interest rates are low, we invest our DCA amount in CL2. If rates are too high, we invest the DCA amount in an index replicating the S&P 500 Total Return.
In other words, if the interest rate paid by the LETF (the €STR) is below a certain threshold x%, we invest the monthly savings in CL2. Otherwise, we invest in an index that replicates the S&P 500 Total Return in dollars.
There could be many other strategies, such as selling CL2 when interest rates are high, or allocating a percentage of monthly savings to CL2 based on interest rates. However, here we will focus solely on this particular strategy.
To find the optimal interest rate threshold at which to switch investments from CL2 to the S&P 500 in dollars, I considered a monthly DCA of a fixed amount between 1988 and 2024 (since I do not have S&P 500 Total Return data before 1988).
I conducted several simulations over the period 1988-2024, varying the interest rate threshold that triggers the switch in investment. For each simulation, I calculated the average daily return 𝜇 and the daily standard deviation 𝜎 for the portfolio. From these 𝜇 and 𝜎 values, I calculated the ratio 100 µ / 𝜎. This ration 100 µ / 𝜎 represents the return μ relatively to the risk taken (the volatility σ). The goal is to determine the interest rate threshold that maximizes this ratio.
Here are the data obtained:
On the graph above for an interest rate below -0.5% per year the portfolio only contains the S&P 500 Total Return. For an interest rate above 10% per year, the portfolio only contains CL2.
We observe that to maximize μ, the portfolio should consist entirely of CL2 (although gains may not necessarily increase due to beta slippage previously discussed).
We can notice that investing in CL2 becomes riskier when the interest rate exceeds 2% per year. Therefore, an interest rate threshold of 2% per year for investing in CL2 appears to be the most optimal for the period 1988-2024. As of 03/05/2024, the borrowing cost is 4% per year.
Here is the graph comparing a DCA strategy in the S&P 500 Total Return with a DCA strategy based on the above algorithm between 1988 and 2024. On the y-axis, we have the multiplicative value. For example, if you had invested €10 per month since 1988, the total would be €10,000 in 2015 (i.e., 1,000 times €10), or €100,000 if you had invested €100 per month (i.e., €100 × 1,000).
The main issue with the 2% per year interest rate threshold is that our DCA strategy would not have invested in CL2 before 2009. Since 2009, the market has been highly bullish, and CL2 has inevitably outperformed. Therefore, the threshold value of 2% per year needs to be reconsidered, as it is influenced by the bullish market of the last fifteen years. In reality, the period from 1988 to 2024 is too short to draw sufficiently reliable conclusions.
Conclusion
We have examined various aspects of Leveraged ETFs (LETFs), from their mechanics and reconstruction to an initial consideration of a strategy. In conclusion, LETFs can be held over the long term and experience significant fluctuations, but there is no guarantee of outperforming the market over extended periods due to their performance being constrained by borrowing costs. In recent years (since around 2010), the S&P 500 has performed very well, and negative interest rates have allowed LETFs to achieve exceptional performance.
Consequently, many investors who focus solely on the past 15 years of performance may be biased and risk investing without adequate knowledge. The risk is that, with higher interest rates and a bearish market, a LETF could perform disastrously. I hope that the analysis of LETFs provided here has helped you better understand these financial instruments and thus invest with greater knowledge.
To conclude, holding a LETF is highly risky, and long-term performance does not guarantee market outperformance. To own one is to be fully aware of the associated risks.
Do not base your decisions solely on this article; make your own judgment. I must reiterate that I am not a financial professional but rather a curious individual who conducted a study on the subject. Therefore, I make no claims about the accuracy of the statements made. Past performance does not predict future results.
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