and Investment Shortfalls

Leveraged and Inverse ETFs replicate the leveraged or the inverse of the daily returns of an index. Several papers have established that investors who hold these investments for periods longer than a day expose themselves to substantial risk as the holding period returns will deviate from the returns to a leveraged or inverse investment in the index. It is possible for an investor in a leveraged ETF to experience negative returns even when the underlying index has positive returns. In this paper, we estimate distributions of holding periods for investors in leveraged and inverse ETFs. Using standard models, we show that a substantial percentage of investors may hold these short-term investments for periods longer than one or two days, even longer than a quarter. We estimate the investment shortfall incurred by investing in leveraged and inverse ETFs compared to investing in a simple margin account to generate the same leveraged or short-selling investment strategy. We find that investors in leveraged and inverse ETFs can lose 3 % of their investment in less than 3 weeks, an annualized cost of 50%. We also discuss the viability of leveraged and inverse leveraged ETFs that rebalance less often than daily and calculate their costs to investors. I