From "2x Long" to "Inverse Decline": Are Leveraged ETFs "Not Living Up to Their Name"?

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A 2x leveraged ETF tracking MicroStrategy has plummeted 65% over the past 12 months, while the company’s stock rose 28% during the same period, bringing the issue of "volatility decay" into the spotlight.

For investors seeking higher returns in a record-breaking bull market, leveraged ETFs were once seen as a shortcut. As of mid-October, assets in single-stock leveraged ETFs had grown to about $40 billion.

But the rapid expansion of such products is exposing more investors to unexpected losses, especially those who misunderstand how leveraged funds work. According to Morningstar, in the past two quarters, traders withdrew nearly $5 billion from leveraged single-stock funds—the first outflow ever recorded for this category.

Meanwhile, ETF issuer Volatility Shares filed last week to launch 27 high-leverage ETFs, including what could be the first 5x leveraged funds in the US.

The US Securities and Exchange Commission has previously objected to high leverage funds, but due to a government shutdown pausing the review of fund applications, these products could be automatically approved for issuance after 75 days.

How Leveraged Mechanisms "Eat Away" Returns

The fundamental reason leveraged ETF performance diverges from the underlying asset over the long term lies in their "daily compounding" structure, which results in what traders call "volatility decay."

The most common type of leveraged ETF offers double the returns of its underlying asset. For example, a 2x leveraged ETF tracking Tesla will rise 10% on a day Tesla gains 5%, but if Tesla falls 5%, the ETF will plunge 10%.

But these funds are designed to deliver a specific multiple (such as 2x) of "single-day" returns, not long-term returns.

For example, suppose a stock and a 2x leveraged ETF tracking it both start at $10:

On Day 1, the stock falls 30% to $7, so the leveraged ETF drops 60% to $4.On Day 2, the stock rebounds 50% to $10.5, making a weekly gain.But for the leveraged ETF, even with a 100% rise (twice the 50% gain), its price only recovers from $4 to $8, still at a loss for the week.

The higher the stock’s volatility, the more likely the long-term returns of leveraged ETFs will be eroded. As Dave Nadig, research director at ETF.com, says:

The more leverage or volatility you add to these funds, the more pronounced all their problems become.

Fund managers also widely warn that such products should not be held long term.

A Painful Lesson for Investors: "Are We Doomed?"

For many retail investors drawn by get-rich-quick stories on social media and only half-understanding the mechanism, this mathematical trap has led to significant actual losses.

The two 2x leveraged ETFs tracking MicroStrategy are a prime example; their surge last year drew social media attention and attracted thrill-seeking investors at an unprecedented pace.

Now, even as the underlying stock is rising, many investors are facing huge losses.

On Reddit investment forums, a user made a desperate post:

As holders of MSTU and MSTX (the two MicroStrategy leveraged ETFs), are we doomed?

Another investor discussing these funds wrote:

If I didn't understand price decay before, I do now. I've learned my lesson and won’t touch leveraged ETFs again.

High Fees Drive Supply Surge

Although large managers like BlackRock and JPMorgan Asset Management avoid such ETFs due to risk, many other institutions are attracted by the hefty management fees.

Leveraged ETFs typically charge around 1% in management fees, much higher than the 0.3% average for actively managed funds.

According to Bank of America analysts, about 200 leveraged stock ETFs are expected to be launched in 2025 alone, bringing the total to 701 as of October. By mid-October, single-stock leveraged ETF assets had reached about $40 billion.

Asset managers have not been deterred by investor losses. Some institutions continue to roll out leveraged ETFs, looking to profit from investors buoyed by recent market rallies.

If regulators don’t act within the 75-day application period, extreme products like the first 5x leveraged funds may be approved for issuance. Analysts note that such funds could be wiped out and liquidated if the underlying stock falls 20% in a day.

Risk Warning and DisclaimerThe market involves risk; investors should be cautious. This article does not constitute personal investment advice and does not take into account individual users’ specific investment objectives, financial situation, or needs. Users should consider whether any opinions, views, or conclusions in this article apply to their own situation. Invest at your own risk. ```