Leveraged exchange-traded funds (LETFs) first appeared in 2006 and were initially viewed as revolutionary investment products. In Reference [1], the authors examined several important aspects of LETFs. Almost two decades later, following numerous market stress events, including the recent 2026 South Korea extreme-volatility episode, they published a follow-up article [2] revisiting the insights and conclusions of their earlier work.
The authors pointed out,
However, to some observers, these products are characterized by issues often cited as contributors to the global financial crisis including (1) inadequate investor education regarding product complexity, (2) systemic risk arising from rebalancing dynamics, and (3) lack of transparency around hidden frictions….
On the second point, there is now less concern about same-direction rebalancing on the broader market in the US given the relatively small footprint of LETPs relative to total AUM, less than 1%. We do note that LETPs have a much larger share of dollar trading volume, some 16%, and their AUM when factoring leverage is actually understated. A major concern lies with high leverage products on single stocks and niche indexes, where history suggests that value can be quickly destroyed in extreme events as in South Korea in July 2026…
Our formal model twenty years ago addressed key questions raised by investors, market practitioners, regulators, policymakers, and the press seeking to understand a new product. In doing so, it demonstrated the value of the scientific approach to market analysis championed by JOIM. This remains an active area of theoretical and empirical research. Important questions about path-dependent returns, volatility, and microstructure effects remain open and relevant to practitioners. Recent events, including South Korea’s market volatility in the summer of 2026, show that these concerns are not merely theoretical; they can have real consequences for markets and everyday investors.
Basically, the core insights from the original paper [1] still hold: LETPs are useful short-term trading tools, but long-horizon returns are path-dependent, daily rebalancing can amplify market moves, and hidden financing frictions can materially erode returns.
In addition, the paper also finds that
- Predictable rebalancing can act as a momentum accelerator near the close. The effect should be stronger in thin markets, highly leveraged products, and products with large AUM,
- LETPs should primarily be treated as tactical, short-term instruments, not simple long-term leveraged holdings.
Let us know what you think in the comments below or in the discussion forum.
References
[1] Cheng, M. and A. Madhavan (2009), The Dynamics of Leveraged and Inverse Exchange-Traded Funds, Journal of Investment Management, 7(4), 43–62
[2] Cheng, M., & Madhavan, A. (2026), Twenty Years of Leveraged and Inverse Exchange-Traded Products: What Have We Learned? Working paper
Article Source Here: Two Decades of Leveraged ETFs
source https://harbourfronts.com/two-decades-leveraged-etfs/
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