Why do leveraged ETFs rebalance daily?
Maintaining a constant leverage ratio allows the fund to immediately reinvest trading gains. This constant adjustment, called
Most leveraged ETFs reset to their underlying benchmark index on a daily basis to maintain a fixed leverage ratio. That is not at all how traditional margin accounts work, and this resetting process results in a situation known as the constant leverage trap.
The two most common strategies for rebalancing are: Periodic rebalancing: You rebalance at fixed intervals, for instance every 6 months, or every year... Threshold-based rebalancing: You rebalance when one of the ETFs in your portfolio goes out of balance by a certain percentage, for instance 5%.
Leveraged ETFs Explained
LETFs primarily use futures contracts, index futures, and swap agreements to magnify the daily returns of the underlying index, stock, or other tracked assets. 7 These derivatives are needed for the daily rebalancing these LETFs require.
Leveraged and inverse funds that have daily resets are attempting to achieve their objectives on a daily basis, not over a week, month or longer period; as a result, clients should not assume or expect the performance of a leveraged or inverse fund over a period of time in excess of one trading day to track or even ...
Most leveraged ETFs “reset” daily, meaning that they are designed to achieve their investment objective on a daily basis. Their performance over longer periods of time may differ significantly from the performance of the underlying index or benchmark during the same period of time.
ProShares UltraPro Short QQQ (SQQQ)
If the Nasdaq-100 falls 1% over a day, then the fund is expected to return 3%. Since SQQQ's leverage resets on a daily basis, holding the fund beyond a single day may compound returns and provide results that are different from the target return.
The Fund seeks investment results for a single day only as calculated from NAV to NAV, not for any other period. The Fund seeks to engage in daily rebalancing to position its portfolio so that its exposure to the Index is consistent with the Fund's daily investment objective.
The fund and the index are rebalanced quarterly and reconstituted annually. QQQ delivers exposure to companies that are at the forefront of transformative, long-term themes such as Augmented Reality, Cloud Computing, Big Data, Mobile Payments, Streaming Services, Electric Vehicles, and more.
Exchange-traded funds (ETFs) may rebalance their portfolios on a regular basis to ensure that the fund's holdings remain in line with its investment objective and strategy. The frequency at which an ETF rebalances its portfolio can vary, and may be daily, weekly, monthly, or less frequently.
Why shouldn t you hold leveraged ETFs?
Leveraged ETFs decay due to the compounding effect of daily returns, volatility of the market and the cost of leverage. The volatility drag of leveraged ETFs means that losses in the ETF can be magnified over time and they are not suitable for long-term investments.
Because they rebalance daily, leveraged ETFs usually never lose all of their value. They can, however, fall toward zero over time. If a leveraged ETF approaches zero, its manager typically liquidates its assets and pays out all remaining holders in cash.
So, if you invest in a 3x leveraged ETF, its return ratio would be 3:1. In turn, should the value of the underlying index increase by 1% on a given day, your returns would actually be 3%. The daily nature of these funds ultimately makes them best suited to be short-term securities.
The daily rebalancing of leveraged and inverse ETFs creates a situation that for periods longer than a day or two the return of a leveraged or inverse ETF will deviate from the margin account benchmark.
ProShares UltraPro QQQ is the most popular and liquid ETF in the leveraged space, with AUM of $21.9 billion and an average daily volume of 67.3 million shares a day. The fund seeks to deliver three times the return of the daily performance of the NASDAQ-100 Index, charging investors 0.88% in annual fees.
Daily leveraged exposure means the compounding effect will be amplified and occur daily, which can have a positive or negative effect on returns over longer periods.
Investors should note that TQQQ's leverage resets on a daily basis, which results in compounding of returns when held for multiple periods. TQQQ can be a powerful tool for sophisticated investors, but should be avoided by those with a low risk tolerance or a buy-and-hold strategy.
Nearly all leveraged ETFs come with a prominent warning in their prospectus: they are not designed for long-term holding. The combination of leverage, market volatility, and an unfavorable sequence of returns can lead to disastrous outcomes.
Leveraged ETFs decay due to the compounding effect of daily returns, volatility of the market and the cost of leverage. The volatility drag of leveraged ETFs means that losses in the ETF can be magnified over time and they are not suitable for long-term investments.
For any holding period other than a day, your return may be higher or lower than the Daily Target. These differences may be significant. Smaller index gains/losses and higher index volatility contribute to returns worse than the Daily Target.
How long should you hold SQQQ for?
The SQQQ is meant to be held intraday and is not a long-term investment, where expenses and decay will quickly eat into returns.
Investors should note that SQQQ's leverage resets on a daily basis, which results in compounding of returns when held for multiple periods.
Historically, SQQQ decays around 7-8% per month, though this would likely be around 4-5% per month during a flat market such as that experienced so far this year.
The index composition is reviewed annually and rebalanced quarterly.
The key word here is "daily." Due to how compounding works, holding SQQQ for longer periods of time may result in unpredictable returns. So, holding SQQQ long term is not recommended as the ETF suffers from significant volatility decay, causing its share price to lose value if held for too long.
