Leveraged ETFs perfomance during financial crisis based on the North American market

Abstract

This paper seeks to evaluate the performance of Leveraged ETFs during the financial crisis. The paper is based on the performance analysis of three 2x bull and 2x bear Exchange Traded Fund respectively traded in the US and Canada. Leveraged ETFs have received much press coverage lately because of their performance related issues. Most of the discussion related to the leveraged ETFs has been focused towards the compounding effect, when funds are held for more than one day. In this paper I have desegregated the effect of compounding and that of i) the management of the fund and ii) the trading premiums/discounts, all of which affect investors‘ returns. The former (i) is influenced by the effectiveness of the manager‘s replication strategy and the cost of leverage. The latter (ii) reflects liquidity and the efficiency of the market. I find that tracking errors were not caused by the effects of compounding alone. Depending on the fund, the impact of management factors can outweigh the impact of compounding, and substantial premiums/discounts caused by reduced liquidity during the financial crisis further distorted performance.