Divergent Influence of Beta Slippage on Leveraged ETPs: A Simulation Approach

Abstract

Investors in exchange-traded products (ETPs) face a number of influencing elements that potentially erode their investments. These factors may include taxes, trading fees, administrative expenses, and rebalancing costs. At the same time, leveraged exchange-traded product (LETP) investors are further burdened with yet another mathematical phenomenon known as beta slippage, which erodes their return on investment. In this article, the authors demonstrate the influence of beta slippage on LETP return on investment. They use the daily S&P 500 Total Return Index (SPXT-TRA) for the period from January 1, 1988 through December 31, 2017, and observe the impact of beta slippage on the rate of return on investment, using ETPs with various leverage ratios. The authors also use the daily mean and standard deviation of SPXT-TRA returns for the same period to simulate daily returns for 300 annual periods to observe the same impact on LETPs. Both the historical returns and the simulated returns demonstrate that beta slippage has a tendency to decay the return on investment compared to the underlying index returns. However, this effect is influenced by the magnitude and variability of returns. The authors find that in time periods with the highest returns, beta slippage impacts investors favorably and amplifies the return on investment. TOPICS: Exchange-traded funds and applications, performance measurement, statistical methods