A fascinating and important study from US Federal Reserve researches looks at ETF Risks and find results that many may not expect. In their white paper, “Are Concerns About Leveraged ETF’s Overblown,” researchers Ivan T. Ivanov and Stephen L. Lenkey argue that concerns about ETF Volatility are overblown.
Most people’s concerns focus on common “perception” as the report explains, that re-balancing leveraged and inverse ETF portfolios poorly influences performance. The researchers in this case, however, disagree. As they wrote in the white paper, “Such reasoning is incomplete because it overlooks the effects of capital flows.” They noted that such concerns about these products are “likely exaggerated.”
The paper counter-intuitively explains that capital that comes in and out of leveraged ETFs actually diminish potential volatility. The capital flows happen often and offset the need for ETFs to then re-balance their portfolios. As the report explains, “The large decline in the value of the S&P 500 during 2008-09 leads to a large capital inflow. This results in more assets under management for the ETF relative to the benchmark case with no capital flows. Then, as the index recovers, the ETF undergoes a greater amount of rebalancing on a day-to-day basis because it has more assets under management.”