Blessing or Curse? Institutional Investment in Leveraged ETFs

We document the increasing role leveraged exchange traded funds (ETFs) play in institutional portfolios over time. A subset of independent investment advisors, quasi-indexers, and transient portfolio managers all make substantive use of these tools. Leveraged ETFs can be used for diversification or to implement strategic bets. Empirical tests suggest that institutional holders of leveraged ETFs predict weak portfolio performance in aggregate, consistent with manager hubris, especially among the set of institutional managers most likely to lack management skill. Interestingly, managers appear to reduce positions in leveraged ETFs following good past performance, potentially to lock in good returns, consistent with compensation-based incentives.