Leveraged ETF decay critique misguided, academics say

Three finance professors argue that leveraged and inverse ETFs carry no inherent loss from their daily rebalance, pushing back on the volatility decay critique in research reported by ETF Trends on Nov. 2.

The paper, by Jennifer Carpenter, Fangzhou Lou and Robert Whitelaw, says the daily reset changes the distribution of returns relative to a strategy that does not rebalance, and the underlying asset's volatility governs the size of that effect. "But there is no inherent loss of value," they wrote. The research traces the criticism to "a severe misunderstanding about the returns that they generate."

For advisors, the holding period, not the stated 3x multiple, is the variable to diligence. A 3x fund promises three times an index's daily move and resets at each close, so a policy statement treating 3x as a multiplier over months describes a payoff the wrapper does not provide.

The mechanics are arithmetic. If a stock gains 10%, a 3x ETF gains 30% before costs, and its leverage ratio slips below three because shareholders hold more equity against the same debt, so the issuer adds exposure at the close to reset. A 9% fall the next day takes the fund down 27%, leaving a two-day loss of about 5% as the rebalance amplifies the decline.

Over several days, that can leave a leveraged long fund underwater while its underlying stock is up. A Dimensional Fund Advisors schematic in the report sets out the pattern.

Academic research cited by GraniteShares' founder and chief executive William Rhind showed a 3x S&P 500 ETF would have returned about 3,300% from 2011 to 2025, against roughly 1,500% for a simple three-times multiple. Rhind said "this so-called 'decay' has often worked in investors' favor too." The difference comes from the rebalance: leverage added after an up day goes to work in a trend that is still running.

Whitelaw is also chief investment strategist at VistaShares, an issuer of thematic and option-based ETFs that reported $984 million in regulatory assets as of Oct. 31. VistaShares has no short and leveraged funds, according to ETF Trends.

GraniteShares listed 4x leveraged oil, gold and silver ETPs in London in October, as Private Wealth Daily previously reported. Those products reset daily as well, which leaves the path as the deciding variable for a holder who stays past one session: a trend that keeps running pays back the added leverage, and a round trip does not.