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An investor writes: “Dollar cost averaging into 50% UPRO and 50% TMF has proved to return an annual growth rate of 33%. Who is dumb enough to waste their time doing anything else?”
The short answer is the old economist’s joke: Sure, it works in practice. It just doesn’t work in theory.
UPRO UPRO, -0.21% is the ProShares UltraPro S&P 500 exchange-traded fund, a high-octane fund that aims to do three times the return of the S&P 500 index every single day. So if the S&P 500 SPX, +0.00% is up 1%, it should be up 3%. And so on.
TMF TMF, -0.18% — Direxion Daily 20+ Year Treasury Bull 3x Shares—aims to do the same thing with long-term Treasury bonds.
After all, if it’s a good idea to invest in a simple portfolio of stocks and bonds, goes the question, why isn’t it three times as good to invest in levered “3x” funds that get you the same stocks and bonds with three times the return?
Way back in 2009, when these levered funds were new, this wild strategy became so popular with mom and pop investors that the Securities and Exchange Commission and the Financial Industry Regulatory Authority put out a joint warning statement about why it was a bad idea.
But those who ignored the advice of their elders and betters, and went ahead and did it anyway, made out like bandits.
By my math, this simple portfolio is up 1500% over the past 10 years. A dollar invested then gets you $16 now.
The boring portfolio of 50% S&P 500 SPY, -0.07% and 50% long term Treasury bonds VUSTX, -1.41% ? Just 200%. A dollar gets you three.
Oops.
Supposedly, this strategy is a route to disaster. These funds are only supposed to give you three times the movement a day. They’re not designed to be held long term.
So why did this work?
To understand better I spoke to Sylvia Jablonski, head of capital markets at Direxion.
And she started by saying, yes, actually, she is aware of clients who have used this strategy and held these funds long-term.
And yes, she says, this strategy worked really well last decade. (Incidentally, if you want to see incredible performance, she says, look at the Direxion Daily Technology Bull 3x ETF TECL, +1.39%, which turned $1,000 into $21,000 last decade.)
But that’s because of the kind of market we saw between 2010 and 2020, she says.
“Markets have been trending upward,” she says. The strategy “works really well when volatility is low and the trend is upward.” Markets have to keep going up. “you have to have low volatility and directional gains—a directional bull market,” she says.
The problem arises in other markets, she adds. Like now, where volatility is high, and the trend isn’t so clear.
“Where it works against you is when you have rangebound volatility, and that’s what we have now,” Jablonski says.
“When the market is up the fund responds by increasing exposure to the index, and then in the event of a loss you’ll generate a greater loss,” Jablonski explains. On the other hand, if the market falls on one day the fund reduces its exposure. If then “the next day it’s up you don’t have enough (invested, and) you didn’t recoup the gains that you lost,” she says.
So it doesn’t work in theory.
But it’s making my head spin. By my math, the regular portfolio of 50% stocks, 50% long-term bonds is up 8% so far this year—but the 3x portfolio is up 21%.
Once again, please, listen to the theory. In the words of Chico Marx, who are you going to believe—me or your own eyes?
There again, if you thought the S&P 500’s 35% drop between Feb. 20 and March 23 this year was alarming, check out UPRO. Even the balanced “3x” portfolio fell three times as much as the simple stock and bond fund.
Maybe this strategy will work over the next 10 years, and hotshots will get lucky again. But I wouldn’t bet my life savings on it.
