Leveraged Funds: Robust Replication and Performance Evaluation
32 Pages Posted: 19 Sep 2016 Last revised: 21 Feb 2019
Date Written: March 1, 2017
Leveraged and inverse exchange-traded funds seek daily returns equal to fixed multiples of indexes' returns. Trading costs implied by frequent adjustments of funds' portfolios create a tension between tracking error, reflecting short-term correlation with the index, and excess return, the long-term deviation from the leveraged index' performance. With proportional costs, the optimal replication policy is robust to the index' dynamics. Overall fund performance is summarized by the implied spread, the product of tracking error and excess return, rescaled for leverage and volatility. The implied spread is insensitive to risk-premia and enables comparisons of funds tracking different factors of an index.
Keywords: transaction costs, performance evaluation, tracking error, leverage, ETFs
JEL Classification: G11, G23
Suggested Citation: Suggested Citation