If beating the index is almost impossible, why not buy a leveraged index?

Who hasn’t asked themselves this question at some point and thought it was a fantastic idea? Without going any further by looking at the historical performance of the S&P500 leveraged x3 ($UPRO) we can see that the return has been 4,000% since 2009, versus 345% for the S&P500.

What is not being taken into account is that throughout this period there have been no falls of more than 40% (in the S&P500 Index); if there had been, the leveraged index would have fallen to 1% of its value and it would have been impossible for it to recover.

This index allows us to include it as part of an asymmetric portfolio in which we have uncorrelated risks. A couple of examples could be the following investment strategy.

A very simple investment strategy

The strategies proposed below are indicative and serves simply to consider the effect of having uncorrelated portfolios in the long term and the implications that leverage and ‘fat tails’ have on the portfolio.

This first approximation is a simple backtest with 60% of the portfolio in cash, 20% of weight in the VIX (volatility index of the S&P500) and 20% in the UPRO and the rebalancing period will be by bands.

This strategy has a CAGR of 13.4%, a max. drawdown of -6.23% and WITHOUT ANY NEGATIVE YEARS!

A more sophisticated investment strategy that beats the market by far

In this second scenario, an asset allocation of 20% will be made in the index that we have talked about previously (UPRO), 20% in a totally uncorrelated asset and where we will try to benefit from market anomalies or ‘black swans’ and to this has been considered very OTM PUTs of the SPY with an expiration date of more than 600 days, to simplify the calculations.

The process that will be used for the calculation will be a monthly rebalancing during each of the months of 2020. This information may indeed be biased due to the ‘black swan’ that happened last year, but it does not seem logical to buy from systematically PUTs that are expensive as done during this backtest. There are strategies with CALLs and PUTs sold that can help us offset the Time Decay of the PUTs bought in the backtest.

Even with all this, the backtest provides us with a return of 630% compared to the 15% that the S&P500 contributed in the same period.

The S&P would have needed 25 years to achieve the same return as our backtest in one year (since 1995).

This article is for informational purposes only, it should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.