Paging Chico Marks.
“Who Are You Going to Believe – Me or Your Own Eyes?,” Comedian famously asked In “Duck Soup”. And we investors are facing a similar challenge from experts and regulators alike who are here to take care of us.
Today’s topic is the famously insane “3X” retirement portfolio that we are told over and over again that we shouldn’t buy because sooner or later it will wipe us out.
It’s been over a decade since the Securities and Exchange Commission warning Mom and pop investors don’t put their investment funds into leveraged mutual funds, which are designed to give them the up and down two or three times the daily performance of stocks and bonds.
It’s been over a year since I pointed out that investors who ignored this wise advice had made more money than Crosses and were laughing all the way to the bank.
Latest news: They’re still making out like bandits, even though they shouldn’t.
Look, I’m not recommending, I’m going to tell you what’s up.
The original portfolio in question in the ProShares UltraPro S&P 500 UPRO is 50%,
Which is designed to give you three times the performance of the S&P 500 stock index and 50% in DirexionDaily 20+ Year Treasury Bull 3X TMF,
Which is designed to give you three times the performance of long-term US Treasury bonds.
So far this year this portfolio, rebalanced quarterly, is up an astonishing 29% — even if it shouldn’t be. Bond and stock markets have been volatile, with particularly tanking and then rallying, and this is considered a poison for these funds.
In contrast the much more sensible portfolio that ignored these volatile funds, and instead split its money evenly between a plain U.S. stock market fund and a plain long-term Treasury bond fund, is up only 9%.
It’s not new.
Over the past decade this 3x portfolio, rebalanced quarterly, would have turned an initial $1,000 investment into $15,100.
Ordinary, 1x equivalent: $2,760, or less than a fifth.
So much for the knowledge of the experts!
This adds to my growing suspicion that reading economics textbooks can give you better financial advice than watching old Marx Brothers movies. (Oh, and trust the Communists to get your economic analysis from the wrong “Marx”.)
Theoretically, these leveraged funds are a disaster waiting to happen for long-term investors. These funds are designed to only give you 3x the performance of the underlying assets—stocks and bonds—per day. They do this by trading in derivatives. Once you hold them for more than a day you start playing the financial equivalent of Russian Roulette. If, say, the stock market rises one day and tanks the next, you could in theory be much worse off than you started with. You are affected by trading costs. And you may be suffering from the famous paradox of percentages—it only takes 100% profit to recover from 50% loss.
Ultra Bond Fund UPRO fell 40% during the bond market in the first three months of this year, and it’s still down about 15%.
I am not presenting any scenes here, although I will not take this risk with my money. But I was ready to take another look at this portfolio after Friday’s sharp stock market sell-off.
When the stock market is bullish, one asset that tends to perform well is US Treasury bonds—and the longer-dated the better. This is arguably the main reason for investors to own some Treasury bonds, regardless of their view of the economy or the stock market. Treasury provides a form of “insurance” in case the stock market tanks and things go to hell in a jam.
PIMCO’s 25+ Year Zero Coupon ETF ZROZ on Friday,
and Vanguard’s Extended Term Treasury ETF EDV,
They rose 3% or more, offering a supportive cushion for portfolios when their stocks declined. But TMF offered more than double the cushion, rising more than double, or more than 7%.
(If you want to get really smart, there are so-called “call options” on TMFs, which give you a long way on the fund’s shares, in the event of a jump of up to 50%.)
No, we certainly shouldn’t take a long-term position in this 3x Treasury Bond Fund as a way to insure the rest of our portfolio. Maybe it worked in practice, and it might work in practice for everyone I know, but it doesn’t work in theory.
Or, as Chico might say, who are you going to believe—the expert, or the marketer?