Leveraged ETF for long term investment - quantitative analysis

Question

I know the question of why leveraged funds (eg. SPXL 3x) are bad for long term investments has been asked a lot. I have seen general answers saying that because of daily re-balancing and volatility decay one would expect to lose money in the long term.

To convince myself I have tired getting data from daily closings from the S&P500 and multiplying by daily returns by 3x (and subtracting ~1% annual fee).

Overall since 1960 I see a 12.1% CAGR for the 3X leveraged vs 7.0% for the S&P500. And over 20y periods it performed better than the S&P for 32 of the 39 intervals.

I am not suggesting putting a whole retirement fund there, as drawdowns can be very large (e.g. -84% in 2008, -61% in 2002), but those numbers seem to contradict the idea I had read that those leveraged funds are an intrinsically bad idea in the long term.

Am I missing something here in my analysis? Or are those funds really not bad in the long term?

Thanks.

The Excel spreadsheet I made is here: https://drive.google.com/file/d/1836cSCd3hghhnJwkZgOWjKq3nhXb-0h8/view?usp=sharing

P.S. I have also double checked that the SPXL does behave daily as 3x the SPX. When I compare the SPXL actual yearly performance vs the one I get from my estimate the actual SPXL performs consistently slightly better.

Answer 1

Here's some interesting information about leveraged ETFs (LETF) that I recently came across elsewhere. I saved it because I'm always interested in understanding market mechanics better to hopefully find an edge. I have not looked at historical data to verify the claim and I apologize for failing to capture the author's name for sourcing.

The more leveraged the ETF, the more sensitive it is to its index’s volatility. The mathematics confirms that when the index’s average daily volatility is at or below .756%, a 4X LETF outperforms the index the most, followed by the 3X and 2X.

When average daily volatility is between .756% and 1.13%, a 3X LETF outperforms the the index the most, followed by the 2X, but the 4X no longer outperforms the index well enough to justify its risk.

When average daily volatility is between 1.13% and 1.51%, only the 2X LETF outperforms the index well enough to justify its risk. When the bull market’s daily volatility exceeds 1.51%, you’re dealing with a high-volatility bull market. This requires a different approach.

Also, here's some recent discussion about this topic.