Leveraged ETFs: The Scary Drift Of SPXL (NYSEARCA:SPXL)

The ProShares Direxion Daily S&P 500 Bull 3x Shares ETF (NYSEARCA:SPXL) is one of the most popular instruments to trade in bullish market conditions. Its daily 3X leverage factor is a source of drift, which may be positive or negative. It must be closely monitored to detect changes in the drift regime. This article explains what “drift” means, quantifies it in more than 20 leveraged exchange-traded funds, or ETFs, and shows historical data on SPXL.

Why do leveraged ETFs drift?

Leveraged ETFs often underperform their underlying index leveraged by the same factor. The decay has essentially four reasons: beta-slippage, roll yield (contango), tracking errors, and management costs. Beta-slippage is the main reason in equity leveraged ETFs. However, when an asset is in a steady trend, leveraged ETFs can bring an excess return instead of a decay. You can follow this link to learn more about beta-slippage.

Monthly and yearly drift watchlist

There is no standard or universally recognized definition for the drift of a leveraged ETF. Some are quite complicated. Mine is simple and based on the difference between the leveraged ETF performance and Ñ times the performance of the underlying index on a given time interval, if Ñ is the leveraging factor. Most of the time, this factor defines a daily objective relative to an underlying index. However, some dividend-oriented leveraged products have been defined with a monthly objective (mostly defunct ETNs sponsored by Credit Suisse and UBS: CEFL, BDCL, SDYL, MLPQ, MORL…).

First, let’s start by defining “Return”: it is the return of a leveraged ETF in a given time interval, including dividends. “IndexReturn” is the return of a non-leveraged ETF on the same underlying asset in the same time interval, including dividends. “Abs” is the absolute value operator. My “Drift” is the drift of a leveraged ETF normalized to the underlying index exposure in a time interval. It is calculated as follows:

Drift = (Return – (IndexReturn x Ñ))/ Abs(Ñ)

“Decay” means negative drift. “Month” stands for 21 trading days, “year” for 252 trading days.

Click to enlarge

The leveraged semiconductors ETFs, both bull (SOXL) and bear (SOXS) have the worst monthly decays: -1.4% and -1.7%, respectively. The highest positive drift is +2.39% for the inverse leveraged silver ETF (ZSL).

SOXS has also the worst 1-year decay with -28.93%, closely followed by the inverse leveraged biotechnology ETF (LABD) at -27.16%. The inverse leveraged long-term bonds ETF (TMV) has the highest positive drift on the same period: +5.47%.

Positive drift comes with a steady trend in the underlying asset, whatever the trend direction and the ETF direction. It means positive drift may come with a gain or a loss for the ETF. Negative drift comes with daily return volatility (“whipsaw”). Whipsaw happens more often in downtrends of the underlying asset. For example, you can see in the table above that all leveraged ETFs in the S&P 500 (bull and bear) have negative drifts in the last 12 months.

SPXL drift history

The next chart plots the 12-month drift of Direxion Daily S&P 500 Bull 3x Shares ETF since inception (11/05/2008). The 12 months of data prior to inception that are necessary for the calculation have been inferred from SPY daily returns.

The historical average is negative: -1.3%. SPXL has suffered a decay since it was launched, but the drift was dwarfed by the bullish trend: the total return is 1841% (23% annualized).

The drift went in negative territory in the March 2020 meltdown due to whipsaw in daily returns. It jumped to 31% in positive territory in April 2021, when the bad period went out of the look-back interval. The stock market had one of the strongest rallies in history, leading to a high positive slippage. While SPY returned about 39.2% in one year, SPXL went up 161.9%. It is about four times the underlying index return. It shows the good side of beta-slippage in a bullish trend. Then, the fund’s price action has become scary in the last 12 months: it has lost about 39%, whereas SPY is down 8%. It looks almost like a 5x leveraging factor!

Performance simulated with synthetic prices from January 2000 doesn’t look good at all. On this period with two deep bear markets, SPXL annualized return would have been inferior to the non leveraged index (2.98% vs 6.86% for SPY). It includes a drawdown of -98%: a clear warning against a buy-and-hold strategy!

The next chart plots the hypothetical drift since January 2000 using synthetic prices before inception. The historical average 12-month drift is -2.0%.

With concerns about a looming recession and a protracted inflation forecast, volatility is likely to stay, whatever the market direction. In these conditions, most equity leveraged ETFs will probably continue to drift in a bad way.

In conclusion, leveraged ETFs are only for seasoned traders who have a good understanding of what happens behind the advertised leveraging factor. Like for any ETF, read the prospectus, and if you have a doubt, stay away.