Hendrik Bessembinder: Constant Leverage & Measuring Investor Outcomes | Rational Reminder 397

Why It Matters

The findings signal that popular leveraged single-stock ETFs can impose substantial hidden costs and harm long-term returns for ordinary investors, while the proposed investor-centric return metrics could reshape how performance and retirement outcomes are measured and regulated. Regulators, advisors and investors should reassess product suitability and reporting standards in light of these results.

Summary

Hendrik Bessembinder told the Rational Reminder hosts that leveraged single-stock ETFs have material costs and tail risks, finding long 2x/3x products underperform a frictionless leveraged benchmark by about 0.79% per month (roughly >9% annually) and short products by ~1% per month. He cautioned against simplistic ‘volatility decay’ narratives, distinguishing real-time leverage dynamics for single stocks versus index-based constant-leverage ETFs. Bessembinder also previewed potential future work on index leveraged ETFs and discussed a pair of papers proposing investor-focused return measures — the sustainable return and proportional sustainable return — that incorporate spending and investor-specific objectives. The conversation stresses the gap between product marketing and actual net investor outcomes and pushes for academic finance to adopt planning-relevant metrics.

Original Description

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In this episode, we welcome back return guest Hank Bessembinder for a deeply analytical conversation spanning leveraged ETFs, volatility, and the future of performance measurement. Hank walks us through his latest research on leveraged single-stock ETFs, clarifying the misunderstood concept of “volatility decay” and decomposing returns into rebalancing effects and frictions. The results are striking: meaningful underperformance relative to simple levered benchmarks, driven by both embedded costs and the mechanics of daily resets. In the second half, we shift gears to a more foundational question: What is a return, really? Hank challenges the dominance of arithmetic averages and even geometric means, arguing that neither truly captures the long-term investor experience. He introduces the concept of the sustainable return—a measure based on the cash flows an investment can support without depleting capital—and outlines how it could reshape academic finance and real-world financial planning.

Timestamps:

0:00:00 Intro

0:07:28 Defining “volatility decay” with respect to constant leverage ETFs

0:12:03 How concerned investors in constant leverage ETFs should be, ex ante, about volatility decay

0:19:09 How the rebalancing costs for long and short levered ETFs differ

0:22:38 How one decomposes levered ETF returns

0:23:59 How live levered single stock ETFs have performed relative to Hank's benchmarks

0:29:49 How common a return less than -100% is

0:33:24 How the distribution of returns for leveraged single stock ETFs look in Hank's simulations

0:38:47 How think most investors should approach the use of single stock levered ETFs

0:43:40 Where academic research has fallen short in its measurement of long-term returns

0:48:03 The problems with using arithmetic mean returns, which are common in academic literature, mean-variance optimization, and calculating Sharpe ratios

0:53:13 Why we can't use log returns to solve these issues

0:56:02 The benefits of measuring performance using dollar weighted returns, or IRRs

0:58:13 The drawbacks of using IRRs

1:02:38 How performance measurement changes when there are portfolio withdrawals

1:10:12 How the proportional Sustainable Return works

1:15:00 What individual stock returns look like through the lens of the Sustainable Return

1:16:12 How Hank hopes that future academic research will incorporate measures like the Sustainable Return

Papers From Today's Episode:

Returns to Constant Leverage Strategies: General Principles and Application to Levered Single-Stock ETFs — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=5369417

Measuring Investor Outcomes — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=5840942

How Should Investors’ Long-Term Returns Be Measured? — https://www.tandfonline.com/doi/abs/10.1080/0015198X.2024.2401765

Links From Today’s Episode:

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Rational Reminder on Instagram — https://www.instagram.com/rationalreminder/

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Benjamin Felix — https://pwlcapital.com/our-team/

Benjamin on X — https://x.com/benjaminwfelix

Benjamin on LinkedIn — https://www.linkedin.com/in/benjaminwfelix/

Cameron Passmore — https://pwlcapital.com/our-team/

Cameron on X — https://x.com/CameronPassmore

Cameron on LinkedIn — https://www.linkedin.com/in/cameronpassmore/