Understanding the Tracking Errors of Commodity Leveraged ETFs
Commodities, Energy & Environmental Finance, Fields Institute Communications, R. Aid et al. Editors, pp.39-63, Springer, 2015
22 Pages Posted: 3 Feb 2014 Last revised: 30 Sep 2015
Date Written: July 3, 2014
Commodity exchange-traded funds (ETFs) are a significant part of the rapidly growing ETF market. They have become popular in recent years as they provide investors access to a great variety of commodities, ranging from precious metals to building materials, and from oil and gas to agricultural products. In this article, we analyze the tracking performance of commodity leveraged ETFs and discuss the associated trading strategies. It is known that leveraged ETF returns typically deviate from their tracking target over longer holding horizons due to the so-called volatility drag. This motivates us to construct a benchmark process that accounts for the volatility drag, and use it to examine the tracking performance of commodity leveraged ETFs. From empirical data, we find that many commodity leveraged ETFs underperform significantly against the benchmark, and we quantify such a discrepancy via the novel idea of realized effective fee. Finally, we consider a number of trading strategies and examine their performance by backtesting with historical price data.
Keywords: Commodities, ETF, Tracking Error, Effective Fee, Trading Strategies
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