Constant leverage certificates: dynamics, performance, and risk-return characteristics

This paper analyzes a relatively new investment product named as constant leverage certificate (CLC), which is designed to provide a multiple of the return of its underlying asset on a daily basis. Based on the literature on leveraged ETFs, which have a similar design, it is well-known that such a strategy does not reproduce the corresponding multiple of the underlying in the long run. But due to the typically much larger leverage factors of CLCs compared to leveraged ETFs, it is questionable whether many of the results found for leveraged ETFs can be applied to these certificates as well. Against this background, I study the drivers of the long-term deviation of the product return from the leveraged return of the underlying, test a generalized version of the theoretical long-term return model originally developed for leveraged ETFs with a simulation study, and analyze the return distribution based on the theoretical model and empirical data. In contrast to prior literature, my results indicate that the effect of compounding is much more pronounced than the noncompounding deviation also for short-term investment periods. The theoretical model, however, is relatively accurate despite much larger leverage factors.