TL;DR: Please please please don’t do this. There are not many better ways to burn money.
There are three premises here:
Russia is undervalued.
Leverage multiplies your returns powerfully if you are risk neutral.
RUSL is the best way to get this leveraged exposure to Russia
I’m going to ignore 1 and focus on 2⁄3. RUSL and RUSS (the sister ticker; RUSS is x3 short) get their exposure by holding shares of RSX.
What would have happened historically if RSX had been overvalued and you called it right, and bought RUSS (this sister ticker to RUSL; it’s triple leveraged short). What about if RSX was undervalued, and bought RUSL? If you look at raw prices, here’s the last four years:
This doesn’t necessarily look awful, but misses a critical factor; both RUSS and RUSL have had significant reverse splits* in the past few years. RUSS had a 1 for 4 split in 2015; that year’s final prices should be thought of as 40.59 / 4 = 10.1475. RUSL had a 1 for 6 split in 2014; that year’s final price should be thought of as roughly 17 / 6 = 2.8333.
It gets worse. RUSS has paid no dividends for the last few years, and RUSL paid one tiny dividend in 2014. Generally leveraged ETFs do not pay dividends. RSX, meanwhile, has paid dividends of 0.519, 0.638, 0.742 and 0.729 in 2015/14/13/12 respectively. A glance at RSX’s price tells you these are not small numbers. Accounting for that the following becomes apparent:
In 2012 RSX went up. If you held it you made a tidy 13.7% return (accounting for dividends). Congratulations on your successful prediction! Unless you used that prediction to buy RUSL of course, in which case you made less than 1%.
In 2013 RSX went down. If you held it you lost 6.5%. If you saw that coming and invested in RUSS, you lost 11%.
In 2014 RSX fell massively. If you held it you lost nearly 45%. If you bought RUSS in anticipation, you do actually make money this time; 124%.
In 2015 RSX moved by less than 0.5% in either direction; down 0.28%. RUSS, however, lost 63%, more than wiping out the gains in the previous year.
Obviously if you guess wrong you do even worse. Reality says that this works really badly. If your theory and reality disagree, it’s generally not reality that’s wrong; this goes double if you aren’t an expert in the industry.
*A reverse split of, e.g. 1 for 4 means that if you owned 400 shares of RUSL the day before the split, you own 100 shares the day after. In the US this is normally used to get prices back into the 10 − 100 range that US exchanges generally prefer their stocks to trade in.
Thanks for the good examples of volatility drag. This is very important for something as volatile as Russia. However, there is a tendency when valuations are very far from the mean to have large runs towards the mean. One example of a consistent run was from 1/30/2015 to 5/15/2015 in 3.5 months the base index, RSX, went up 39%. During the same time, RUSL went up 137%. Cubing would imply 167% increase, so not bad. Of course there is no guarantee that this will happen, but if it does, the investment will make a lot of money. But you are correct that if mean reversion takes a long time, leverage may be no better than the underlying index, and could even be negative returns.
Mean reversion plays generally have a timeline of years; I assumed that’s what you were proposing. This should be obvious from the fact that you could have made the exact same mean reversion argument at the end of 2014 (2014′s massive drops from the Ukraine crisis were when Russia arguably became undervalued according to your metrics), but actually RSX barely moved in 2015 as a whole. Sure if you cherry-pick the high in May 2015 you do well; hindsight-based cherry-picking always does well.
Over very short time frames (like <6 months), RUSS/RUSL are probably fine because there’s limited opportunity for the transaction costs to build up. That is in fact what they are intended for; short-term bets. But if you’re investing on the timeline of years, they’re really bad, which is hopefully amply demonstrated by the (non-cherry-picked) data I gave for the last few calendar years.
Indeed, I did invest in non-leveraged Russia in 2014 because it was undervalued. But only now that it is extremely undervalued am I willing to make the bet on rapid upward movement where it makes sense to have leverage.
TL;DR: Please please please don’t do this. There are not many better ways to burn money.
There are three premises here:
Russia is undervalued.
Leverage multiplies your returns powerfully if you are risk neutral.
RUSL is the best way to get this leveraged exposure to Russia
I’m going to ignore 1 and focus on 2⁄3. RUSL and RUSS (the sister ticker; RUSS is x3 short) get their exposure by holding shares of RSX.
What would have happened historically if RSX had been overvalued and you called it right, and bought RUSS (this sister ticker to RUSL; it’s triple leveraged short). What about if RSX was undervalued, and bought RUSL? If you look at raw prices, here’s the last four years:
2012: RSX 27.62 → 30.68, RUSS 34.4 → 13.77, RUSL 34.27 → 34.4
2013: RSX 30.68 → 27.93, RUSS 13.77 → 12.25, RUSL 39.5 → 28.05
2014: RSX 27.93 → 14.79, RUSS 12.25 → 27.41, RUSL 28.05 → 17
2015: RSX 14.79 → 14.23, RUSS 27.41 → 40.59, RUSL 17 → 10.23
This doesn’t necessarily look awful, but misses a critical factor; both RUSS and RUSL have had significant reverse splits* in the past few years. RUSS had a 1 for 4 split in 2015; that year’s final prices should be thought of as 40.59 / 4 = 10.1475. RUSL had a 1 for 6 split in 2014; that year’s final price should be thought of as roughly 17 / 6 = 2.8333.
It gets worse. RUSS has paid no dividends for the last few years, and RUSL paid one tiny dividend in 2014. Generally leveraged ETFs do not pay dividends. RSX, meanwhile, has paid dividends of 0.519, 0.638, 0.742 and 0.729 in 2015/14/13/12 respectively. A glance at RSX’s price tells you these are not small numbers. Accounting for that the following becomes apparent:
In 2012 RSX went up. If you held it you made a tidy 13.7% return (accounting for dividends). Congratulations on your successful prediction! Unless you used that prediction to buy RUSL of course, in which case you made less than 1%.
In 2013 RSX went down. If you held it you lost 6.5%. If you saw that coming and invested in RUSS, you lost 11%.
In 2014 RSX fell massively. If you held it you lost nearly 45%. If you bought RUSS in anticipation, you do actually make money this time; 124%.
In 2015 RSX moved by less than 0.5% in either direction; down 0.28%. RUSS, however, lost 63%, more than wiping out the gains in the previous year.
Obviously if you guess wrong you do even worse. Reality says that this works really badly. If your theory and reality disagree, it’s generally not reality that’s wrong; this goes double if you aren’t an expert in the industry.
*A reverse split of, e.g. 1 for 4 means that if you owned 400 shares of RUSL the day before the split, you own 100 shares the day after. In the US this is normally used to get prices back into the 10 − 100 range that US exchanges generally prefer their stocks to trade in.
Thanks for the good examples of volatility drag. This is very important for something as volatile as Russia. However, there is a tendency when valuations are very far from the mean to have large runs towards the mean. One example of a consistent run was from 1/30/2015 to 5/15/2015 in 3.5 months the base index, RSX, went up 39%. During the same time, RUSL went up 137%. Cubing would imply 167% increase, so not bad. Of course there is no guarantee that this will happen, but if it does, the investment will make a lot of money. But you are correct that if mean reversion takes a long time, leverage may be no better than the underlying index, and could even be negative returns.
Mean reversion plays generally have a timeline of years; I assumed that’s what you were proposing. This should be obvious from the fact that you could have made the exact same mean reversion argument at the end of 2014 (2014′s massive drops from the Ukraine crisis were when Russia arguably became undervalued according to your metrics), but actually RSX barely moved in 2015 as a whole. Sure if you cherry-pick the high in May 2015 you do well; hindsight-based cherry-picking always does well.
Over very short time frames (like <6 months), RUSS/RUSL are probably fine because there’s limited opportunity for the transaction costs to build up. That is in fact what they are intended for; short-term bets. But if you’re investing on the timeline of years, they’re really bad, which is hopefully amply demonstrated by the (non-cherry-picked) data I gave for the last few calendar years.
Indeed, I did invest in non-leveraged Russia in 2014 because it was undervalued. But only now that it is extremely undervalued am I willing to make the bet on rapid upward movement where it makes sense to have leverage.