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

See all articles by Kevin Guo

Kevin Guo

Columbia University

Tim Leung

University of Washington - Department of Applied Math

Date Written: July 3, 2014

Abstract

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

Suggested Citation

Guo, Kevin and Leung, Tim, Understanding the Tracking Errors of Commodity Leveraged ETFs (July 3, 2014). Commodities, Energy & Environmental Finance, Fields Institute Communications, R. Aid et al. Editors, pp.39-63, Springer, 2015. Available at SSRN: https://ssrn.com/abstract=2389411 or http://dx.doi.org/10.2139/ssrn.2389411

Kevin Guo

Columbia University ( email )

6 Dorchester Lane
Newtown, PA 18940
United States

HOME PAGE: http://www.columbia.edu/~klg2138

Tim Leung (Contact Author)

University of Washington - Department of Applied Math ( email )

Lewis Hall 217
Department of Applied Math
Seattle, WA 98195
United States
9253381749 (Phone)

HOME PAGE: http://faculty.washington.edu/timleung/

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