## Use of Leveraged ETFs

Leveraged ETFs are generally not a great investment for a long term investment since they do not necessarily behave as we might expect. One is a simple mathematical reason. Consider the 2 scenarios shown in the table below. The first scenario considers a stock that moves sideways by moving up 1% one day, down 1% the next and repeats this pattern. The second scenario is a bullish scenario where the stock moves up 1%/day for 2 consecutive days and then retraces 1% on the next day – the 3-day pattern is repeated.

In the first scenario we see that the loss on an unleveraged asset is \$12 – so the double should be \$24 right? but no – it’s \$48!

In the second (bullish) scenario our unleveraged asset is up \$820, so our double should be up \$1,640, yes? but no – we’re up \$1680 – nice but ??? For an inverse ETF simply change all the signs and we get the same result to the downside.

The reason is that the leveraged portfolio behaves like compound interest – it benefits us in a strong continuous move in one direction (greater than 2x returns) but generally hurts us in oscillating markets.

There are other considerations that do not work in our favor for inverse ETFs – these occur due to the fact that the allocation of shares in the ETF needs to be re-balanced every day (resulting in tracking errors) and that dividend payments need to be accounted for. However, the math is the easiest to understand.

David

## Examining a Basic Portfolio of 25 Exchange Traded Funds

Investor building a global portfolio need from 15 to 25 ETFs or approximately the same number used in The Feynman Study.  In this example portfolio I am using the upper limit of 25 ETFs.  What I did was to run the numbers using the Hoadley-HedgeHunter spreadsheet and then follow the percent-shares recommendation as you will soon see below.  But first we examine the efficient frontier graph.

Efficient Frontier:  With a portfolio concentrated in U.S. Equities we expect the diamond on the efficient frontier to reside northeast of the optimized portfolio.  No surprise here.  This is an aggressive portfolio, but the ITARR will help to damp out volatility when this bull market goes into retreat.

Rankings:  Here we have the latest ranking of the 25 ETFs.  Note the weakening (check the 13-Day EMA) that is beginning to show with even the top ranked performers.  In several cases the price of the ETF is now below its 13-Day EMA.  One needs to move some distance down the list before we see weakness in the “Golden Cross” or when the 13-Day EMA moves from above to below its 49-Day EMA.

Keep an eye on the momentum percentage for SDS as that ultra-short ETF has been racking up 100% numbers for a number of days.  While SDS is certainly not a buy it is an ETF of interest.

## Kenilworth Update: 8 August 2013

Review time is here again for the Kenilworth Portfolio so here is the drill.

1. Examine the Efficient Frontier graph to see where the portfolio stands with respect to an optimized portfolio.
2. Run out a rankings data table to identify the top performing securities.  One wants to include a sufficient number of low correlated options so the portfolio can be shifted adequately when a correction arrives.
3. Look over the Buy-Hold-Sell data table to see if any adjustments are necessary.
4. Examine the Percent Shares data table if one is following the MOM model.
5. Finally, check the performance numbers.

Efficient Frontier:  The current portfolio lies just a little below the optimized portfolio (small red dot) as well as the former optimized portfolio (small blue dot).  If one of the goals is to drive a portfolio toward optimization, the Kenilworth is in good shape.  Maybe a little tweaking is in order.