Little Ado About Volatility
Spikes in volatility levels can impact returns on a fund’s portfolio. The relatively low leverage point (1.25X) for PortfolioPlus ETFs provides less impact of negative compounding than highly leveraged ETFs, making them potentially more suitable for long-term investors.
HOW VOLATILITY AFFECTS PORTFOLIOPLUS ETFs
PortfolioPlus ETFs are a suite of exchange traded funds that add 25% more daily exposure to popular broad-based indexes. These ETFs allow investors to obtain $1.25 worth of daily exposure to their benchmark index for every $1.00 invested, with little change to a portfolio’s asset allocation strategy.
The PortfolioPlus ETFs seek investment results that are 125% of the return of a benchmark index for a single day. These ETFs should not be expected to provide 1.25 times the return of the benchmark’s cumulative return for periods greater than a day. In order to achieve their investment objectives, the PortfolioPlus ETFs must rebalance their exposure ratio on a daily basis, which means that the returns of these ETFs are the product of a series of daily returns over time.
This product of a series of daily returns over time is known as compounding. Compounding will cause an ETF’s performance to vary or “drift” from that of the performance of its benchmark index. Compounding affects all investments, but has more impact on leveraged funds, particularly when held during periods of higher index volatility.
PortfolioPlus S&P 500 ETF vs. S&P 500 Index (1/15/16 -2/12/16)
Past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate. An investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance quoted. For the most recent standardized performance and month-end performance, click here.
WHY DOES IT MATTER?
Although compounding can help performance over time, it has a negative affect during periods of high volatility. The following example illustrates that increased volatility has a negative effect over periods of elevated volatility.
The S&P 500® Index experienced a spike in volatility over the period from 1/14/2016 to 2/12/2016. The benchmark index declined 2.77% over the holding period. The PortfolioPlus S&P 500® ETF (PPLC) declined 3.55%. That’s 0.06 percentage points less than the 125% of the benchmark’s return. It’s important to understand why this effect occurs, but also import to recognize that, even in this period of high volatility, the variance is not very substantial.
THE LONG RUN. WHEN LESS MAY BE MORE.
Compounding works both ways. Sustained market trends and periods of low volatility can result in positive effects on returns. Over a longer timeframe, the same S&P 500® Index experienced much less overall volatility than in the previous shorter time period.
PPLC’s benchmark index gained 48.53% over the holding period. PPLC gained 61.88%. That’s 13.35 percentage points MORE than 125% of the benchmark’s return.
Depending upon the path of the index over longer periods, compounding may have a positive or negative impact on the returns of leveraged funds. Due to periods of negative compounding caused by index volatility, a fund’s return may be negative in the same period that its index’s return is flat or positive. PortfolioPlus ETFs are intended to be used by investors who understand leverage risk and the effects of compounding, and intend to monitor their portfolios.
PortfolioPlus S&P 500 ETF vs. S&P 500 Index (2/11/16 – 11/30/17)
Past performance does not guarantee future results. For the most recent standardized performance and month-end performance, click here.
POTENTIAL FOR ENHANCED RETURNS WITH MINIMAL NEGATIVE COMPOUNDING
Unlike highly leveraged ETFs employed by short-term traders, PortfolioPlus ETFs can potentially be used for longer term investors. PortfolioPlus ETFs help you seek enhanced daily returns with minimal negative compounding, allowing investors to manage them easily within longer term asset allocation strategies.
During periods of low volatility in rising markets the ETFs provide added strength that can overcome the short-term impact of negative compounding.
SPX and Its Rolling 30-Day Index Volatility
The graph above shows total cumulative returns and volatility of the S&P 500 since 12/31/1985. The straight diagonal line in the chart represents a trend line. The returns scale starts at 0%.
If you are a long-term investor who counts on the principle that markets generally rise over time, and periods of extreme volatility are typically short in duration and less common than periods of low to moderate volatility, then you can see how PortfolioPlus ETFs can potentially add value to your portfolio.