Why Invest with Leverage? (3/16)

If diversification is a free lunch, then leveraged diversification can be a free retirement nest egg.

Free Lunch

Since 1952, investment portfolio diversification has been known as the “only free lunch in finance,” thanks to Harry Markowitz, Nobel Prize winner and father of Modern Portfolio Theory. However, just as all lunch menus are not created equal, neither are all investment portfolios.

So, which leveraged ETF portfolios have historically given you the chance of earning a free retirement nest egg, with a tolerable amount of risk?

Leveraged ETFs

In recent years, the exchange-traded fund (ETF) landscape has expanded to include 2x and 3x leveraged ETFs, giving us an important new set of tools for the investing toolbox. When the leading leveraged asset class ETFs are used efficiently, they present an extraordinary opportunity for investors to enhance performance.

Hopefully, regulators will recognize these benefits when they review capping the leverage on these funds.

InvestableBenchmarks.com

At InvestableBenchmarks.com, ETF Portfolio Management (ETF PM) provides an efficient range of strategically diversified investment portfolios, including leveraged ETF portfolios, that present an important starting point for all investors.

For example, we estimate that our Income & Growth 3x portfolio delivered 19% annualized this past decade, or 483% in total return, with a gain of 2% in the crash of 2008. This performance trounces the S&P 500’s return of 7% annualized, or 101% in total return, with a loss of -37% in the crash of 2008.

However, Income & Growth 3x does require active risk controls at times, as this portfolio fell by -17% in 2001, after gaining 22% in 2000. Using just 1.5x leverage, the Income & Growth 1.5x portfolio annualized 10% this past decade, and lost just -4% in 2001, and -1% in the crash of 2008.

For an aggressive growth example, we estimate that our Growth 3x investable benchmark returned 26% annualized this past decade, or 1,017% in total return, with a loss of just -2% in 2008. However, Growth 3x clearly requires active risk controls at times, as this portfolio fell by -41% in 2001.

Long-Term Treasuries (TLT)

ETF PM’s investable benchmark portfolios have delivered extraordinary results through the disciplined use of leading ETFs, and treasuries, especially long-term Treasuries (TLT). Historically, when the equity market has crashed, long-term Treasuries have delivered important portfolio protection.

Since many of the balanced mutual funds on Wall Street tilt towards growth, without using long-term Treasuries for the majority of their fixed income exposure, they exhibit volatility that would make leverage unfathomable. However, when ETF PM’s investable benchmarks are employed with discipline and risk controls, leverage may be used safely and effectively.

The Bottom Line

Investors appreciate the ability to use leverage in buying their homes, and they may develop an appreciation for leverage on their liquid long-term investment assets as well. The investable benchmarks present an extraordinary opportunity for investors to see how leveraged ETF portfolios with strategic diversification may deliver far more than a free lunch.

All of that said, past performance is never a guarantee of future results, and leveraged ETFs often do not deliver their exact multiple of the underlying index return they target. Investors should be careful to engage leverage slowly and cautiously. While the investable benchmark portfolios have delivered exceptional performance, we still encourage investors to employ active trend following risk controls when making portfolio allocations using leverage.

Note: ETF PM is currently working to find the right strategic partner(s) to scale InvestableBenchmarks.com into an ETF of ETFs fund family. The investable benchmark portfolios are currently offered via separate client investment accounts.

Contact ETF PM to learn more.

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ETF Portfolio Management, LLC
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Email: info@etfpm.com

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