SPXL: Long-Term Potential But Tread Carefully (2024)

Thesis

Direxion Daily S&P 500 Bull 3X Shares (NYSEARCA:SPXL) is a possible way to gain enhanced exposure to the market in a way that will amplify its performance in the short term. However, I also consider it a potentially attractive option for long-term investing.

The risks associated with holding such a fund for a long time are very discouraging, no doubt. Though I personally see SPXL as attractive for long-term holding, it's necessary to understand that it can underperform during flat and declining markets. But with the right level of exposure, I would argue that an investor can make an intelligent bet here if they can endure the drawdowns.

What does SPXL do?

SPXL was issued by Direxion Investments on November 5, 2008, and is managed by Rafferty Asset Management, LLC. Currently, it has $2.85 billion in AUM.

The ETF's goal is to deliver 3 times the daily performance of the S&P 500 index through the use of swaps and futures. In other words, this is a fund that aims to considerably amplify the daily S&P 500 performance. For this reason, it should be obvious that this is not for the faint of heart. The sponsor even warns that investors can lose their entire principal if the S&P 500 declines by more than 33% in a day. That, of course, is an extreme scenario but it allows us to fully appreciate how volatile SPXL can be if it achieves its goal most of the time.

With that being said, it could prove of great utility for those with a short-term bullish bias on the market. But I am a buy/hold investor, so naturally, I was wondering if SPXL can be used as a way for long-term exposure to the market with amplified volatility and an "unlocked" potential of market-beating returns. Well, let's see...

Performance

It should be noted that the fund is not designed to reflect the performance of the S&P 500 multiplied by 3 in any longer time frame than one trading day. And though it would be unfair to judge it in this way to measure its efficiency, the long-term picture by which buy/hold investors measure every opportunity demands it:

As you can observe above, since the fund's inception date, it significantly outperformed the SPDR S&P 500 ETF Trust (SPY). SPY delivered total returns of nearly 500% over that period, while SPXL provided a total of approximately 2,400%.

Before I proceed with my thoughts on the long-term investment merit here, I would like to first get something out of the way. When I cover an ETF, I judge its performance within the context of multiple similar options out there that aim to do the same thing. Here, unfortunately, I was only able to find the ProShares UltraPro S&P500 (UPRO). However, I would like to also take a look at the ProShares UltraPro QQQ (TQQQ) which is different in that it uses the Nasdaq 100 but similar in that it aims to amplify the Nasdaq 100 performance by 3 times on a daily basis.

SPXL and UPRO seem to have the same efficiency with insignificant deviation in performance. Predictably, TQQQ managed to outperform both by a wide margin due to the more concentrated index that it tracks in conjunction with the overall trending markets. I am indifferent to the differences between the NASDAQ 100 and S&P 500, so I am interested to also see what the risk profile of each fund looks like.

Source: portfoliovisualizer.com (Mar 2010 - May 2023)

Though I expected to find similar risk profiles between SPXL and UPRO, I couldn't imagine that TQQQ would come with a superior Sharpe ratio. It was predictable, however, that it would be less correlated to SPY. That being said, its maximum drawdown was significantly more painful.

Regardless, I believe that TQQQ is the best choice here because of its superior risk-adjusted returns. But, of course, if someone is skilled in timing the market and is more familiar with the S&P 500, I guess my preference shouldn't be of value to them.

Now, if you were to allocate a bit to either fund for a long period, what would appear to be the most attractive option? Below, I will show you what would happen to a portfolio consisting of SPY only, one with 10% in SPXL, another with 10% in UPRO, and yet one more with 10% in TQQQ.

Source: portfoliovisualizer.com (Jan 2011 - May 2023)

In about the last 12 years, SPXL and UPRO would have helped you do a little bit better than the market. The problem is that volatility is relatively worse in this case. As we saw before, these funds have poor Sharpe ratios. TQQQ, on the other hand, has performed better without too much extra volatility than SPXL and UPRO have had.

In any case, I believe SPXL is still an attractive instrument and it would be unfair to simply dismiss it only because I would prefer to place a bet in TQQQ. I believe that an investor can use it as an effective satellite in their portfolio without trying to time the market. However, the volatility tax can do some frightening things to your allocation in the short term. Nobody can know what you will have to experience if you buy today.

Risks

Here, I would like to list some of the most significant risks associated with investing in SPXL. For a complete list of the risks, make sure to read the fund's prospectus and SEC's related article as leveraged ETFs like SPXL carry unusually higher risk than unleveraged ones.

• Volatility and Beta Slippage Risk: The fund aims to 3x the performance of the index on a daily basis and rebalances its leverage each day, which can result in a long-term deviation from its daily target. The effect of compounding can result in capital erosion.
• Leverage Risk: The ETF uses leverage in order to magnify the performance of the underlying index by a factor of 3. Because of this, it may suffer a complete loss of its net assets if the index drops by more than 33% in a day.
• Derivatives Risk: As SPXL uses derivatives to gain exposure to the index, it is subject to unique risks associated with their use such as imperfect correlations with the underlying index, counterparty risk, higher volatility, liquidity, and valuation, among others.

It's also very important to understand that the performance which I assessed above is based on the past decade or so; a period of a strong trend observed in equities. Leveraged ETFs like SPXL can flourish in such a market but it may not be repeated for a while and this can have a huge impact on your investment. In fact, if a trend isn't realized for an enduring period for their investment, investors could suffer significant capital erosion.

Please, understand that on an isolated basis, investing in SPXL is speculation and I, myself, view it as a wise choice only within the context of a very small portion of one's portfolio allocated to it.

Verdict

In conclusion, I believe that SPXL is a decent choice for those looking to make a long-term bet in beating the S&P 500. Since I cannot time the market, I would view it as an attractive approach to simply expose some of my capital to it until I create a personally significant return and then liquidate my principal amount; I expect this to remove much of the emotional attachment to my position and this will be very useful if I intend to hold for the long term. I couldn't see myself approaching this in any other way right now.

However, I view TQQQ as a better choice here if you're indifferent to the underlying index. I expect the more concentrated Nasdaq 100 to continue to outperform the S&P 500 in the long term and exposure to it through leverage which TQQQ provides can deliver better returns. The added risk should be carefully considered, of course, but I believe it's worth taking because of the superior risk-adjusted returns of TQQQ as shown above.

But I am very interested to know your opinion on this as you may have different reasons to prefer SPXL over others or even none of these leveraged vehicles at all. So leave a comment and let me know your thoughts. Thank you for reading.

Konstantinos Kosmidis