Paging Chico Marx.
“Who are you gonna believe—me or your own eyes?,” the comedian famously asked in “Duck Soup.” And we investors are facing a similar challenge from the experts and regulators who are here to look after us.
Today’s topic is the famously crazy “3X” retirement portfolio that we are repeatedly told we Must Not Buy because sooner or later it will wipe us out.
It’s over a decade since the Securities and Exchange Commission warned Mom and Pop investors not to put their investment funds into leveraged mutual funds that are designed to give them two or three times the daily performance of stocks and bonds, up and down.
It’s over a year since I reported that investors who ignored this wise advice had since made more money than Croesus and were laughing all the way to the bank.
The latest news: They are still making out like bandits, even though they are not supposed to.
Look, I’m not making recommendations, I’m just telling you what’s happening.
The basic portfolio in question is 50% in ProShares UltraPro S&P 500
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
which is designed to give you three times the performance of long-term U.S. Treasury bonds.
So far this year this portfolio, rebalanced quarterly, is up a stunning 29% — even though it shouldn’t be. The bond and stock markets have been volatile, with bonds especially tanking and then rallying, and that’s supposed to be poison to these funds.
By contrast the much more sensible portfolio that ignored these volatile funds, and instead split its money equally between a plain U.S. stock market fund and a plain long-term Treasury bond fund, is up just 9%.
This isn’t new.
Last decade this 3x portfolio, rebalanced quarterly, would have turned an initial $1,000 investment into $15,100.
The simple, 1x equivalent: $2,760, or less than a fifth as much.
So much for the wisdom of the experts!
It’s adding to my growing suspicion that one can get better financial advice watching old Marx Brothers movies than you can from, say, reading economics textbooks. (Oh, and trust the Communists to get their economic analysis from the wrong “Marx”.)
Theoretically, these leveraged funds are a disaster waiting to happen for long-term investors. These funds are designed only to 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 longer than a day you are starting to play the financial equivalent of Russian roulette. If, say, the stock market rises one day and tanks the next, you could in theory end up much worse off than you started. You get hit by trading costs. And you can suffer from the famous paradox of percentages—it takes a 100% gain simply to recover from a 50% loss.
The ultra bond fund UPRO fell 40% in the first three months of this year during the bond market rout, and it is still down about 15%.
I’m not offering a view here, though I wouldn’t take this risk with my own money. But I was drawn to take another look at this portfolio after Friday’s sharp stock market selloff.
When the stock market tanks, the one asset that tends to do well are U.S. Treasury bonds—and the longer-dated the better. That’s arguably the main reason for investors to own some Treasury bonds, no matter what view they take of the economy or the stock market. Treasurys offer a form of “insurance” in case the stock market tanks and things go to hell in a handcart.
On Friday PIMCO’s 25+ Year Zero Coupon ETF
and Vanguard’s Extended Duration Treasury ETF
rose 3% or more, offering a helpful cushion for portfolios while their stocks fell. But the TMF offered more than twice the cushion, rising more than twice as much or 7%.
(If you really wanted to be clever, so-called “call options” on the TMF, which gives you a toehold on the fund’s shares in case they rise a long way, jumped as much as 50%.)
No, of course we shouldn’t take a long-term position in this 3x Treasury Bond fund as a way to insure the rest of our portfolios. It may have worked in practice, and it may carry on working in practice for all I know, but it doesn’t work in theory.
Or, as Chico might say, who you gonna believe—experts, or the market?