Are leveraged ETFs cheaper than using leverage?

Question

Is using leveraged ETF cheaper than borrowing money and buying regular 1x ETF? Let's assume that we're rebalancing daily and interest rate for borrowing is something like 2.66% (taken from Interactive brokers - benchmark + 1.5%). One such example could be TLT and TMF.

I'd say that using leveraged ETF could be cheaper because they can finance it more effectively using financial derivatives, on the other hand expenses are larger as well. But there are other things like tracking error, etc.

Answer 1

Leveraged ETF have negative gamma: the higher the volatility of the underlying index the bigger the negative drag.

This is a big pitfall of those instruments because one can be correct with the overall forward direction of the market for say the next 1 year and still lose money with a LETF. For example if one bets the SPX will go down over next 12 months and invests in a 3x short ETF on S&P500 then the final payoff after 1 year is highly dependent on the path taken by the index:

• if S&P500 goes down say 10% over the year in a straight line (low vol) one could indeed make like 30%
• if S&P500 goes down 10% over the year but with high volatility (say a large rally during H1 and a fall during H2): the investor could still be losing money comes year end.

This type of path dependent behavior would not happen had one simply taken a leveraged position (say shorting ES-futures and rolling them for example)

Answer 2

yes. leveraged fund borrow at competitive rates. retail traders borrow at 5% or more , but some brokers are less.