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Monday, December 27, 2021

Prep for 2022-Indexes vs 3X Indexes - Investment Magic!

According to the latest (Sep 2021) SPIVA Index Scorecard 70% of all active managers could not beat the S&P500 Index. Other studies show that managers who DO outperform have "below random" returns in the following three years. To nail the point, of the "Top 250 Mutual Funds" listed in this weekend's (12/24/2021) Wall Street Journal, only 7 beat the Vanguard Admiral S&P 500 mutual fund. 8 (other index) funds matched it.  This is obviously NOT a representative sampling but it was good enough for the Wall St. Journal. 

So we get it, the original Malkiel and Bogle (buy the earliest editions you can find) were right all along (as if the success of Vanguard hasn't proved it for a generation!) buy and hold the index fund. It's a heck of a good portfolio!

Index ETF or 3X ETF?

Anticipating a buy on the year-end close this Friday December 31st and hold for all of 2022, this post compares, mainly, the risks, of holding the major index ETFs versus their 3X ETFs. 

Why ETFs? Well, while they are closed in the after-hours, unlike the index futures, they cannot trade outside normal market hours. After LONG history we have to agree that the lack of trading ability is a GOOD thing, an EDGE, for any investor.

Futures also have expirations and, perhaps, rolls which ETFs do not have. You CAN buy and hold an ETF for years with NO taxable event until you sell. Futures mark to market every year.  

What about your thirst for leverage? You can buy ETFs on margin or you can buy 3X ETFs outright with no margin costs - how they do that is magic.

Using Yahoo's full year daily historical data for the SPY and QQQ outright ETFs and the SPXL and TQQQ 3X ETFs since inception (note the TQQQ did not trade until and could not be compared until 2010), we get the following results:

Drawdown = (Yearly low/yearly high) -1
Return = (Ending price - starting price) / starting price
Start date = Last trading day each prior year.
End date = Last trading day of each year.
2021=Year-to-date as of the close on 12/23/2021
Source: Yahoo Finance

The SPY average return 2011 - 2021 was a remarkable 17%!  Although, SPY's worst drawdown within any given year was Covid's 2020 -41% decline. The 3X SPY, SPYXL average return was 48%, HIGHER than 3 times the SPY. Oddly enough, the worst SPXL drawdown was -73%, significantly better than 3 times -41% or -123% from a multiple position in the SPY. As far as SPY goes, the 3X ETF is signifcantly BETTER!

For the QQQ, the TQQQ average drawdown of -20% is WORSE the QQQ's -26% forget about the multiple. The average returns, though, were as expected.  Given the above results, with an eye to the 2020 worst declines, there appears to be NO advantage to owning the outright ETFs. 3X ETFs do the same or better on paper.

What about the mechanics of my hypothetical $100,000 investment on the 12/31/2021 close?

Investing

The following compares characteristics of buying the above One X and 3X ETFs:




See the magic. How does buying 3X and arguably NINE TIMES the return COST LESS and RISK LESS than buying the 3X on margin*? Note also, somehow buying 3X ETFs increases your exposure with no debt and no chance of margin calls. Finally, note that the exposures are NOT exact. The $47,000 invested in 100 SPY at 10% earns $4700. The $13,967 at 30% earns "roughly" the same. 

And yes, your risk of loss IS great, SPXL and TQQQ drewdown -73% and -59%, respectively, but you paid cash and can carry the position through the decline with NO margin calls. Loading up on 300 shares each of the SPXL and TQQQ will guarantee a wild ride with only your original $100K at risk.

*At my broker, 3X ETFs are virtually not marginable, so you HAVE to pay cash.  An unnamed risk here, the TRUE  unmentioned risk, is what if the 3X ETFs default? Or get delisted? This happened to select volatility and commodity instruments but none with the history/pedigree of SPXL and TQQQ.  Also, I had to revise this post because my drawdown numbers were slightly off and they are now corrected. :-)

Disclaimer: Posts are for education only, may be subject to change without notice, and, while prepared with care, may be subject to omissions and errors. Send request to gdrahal@outlook.com to follow this blog and for additional information. 

© 2021 George Rahal.





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