
Medallion Fund “Stretches Explanation to the Limit,” Professor Claims - SirLJ
https://www.institutionalinvestor.com/article/b1k2fymby99nj0/Famed-Medallion-Fund-Stretches-Explanation-to-the-Limit-Professor-Claims
======
jjoonathan
Of the wild theories I've heard to explain the Medallion Fund, my favorite is
the "money wormhole." I have no finance qualifications whatsoever -- I just
stick my money in index funds -- but I love a good conspiracy theory, so here
goes.

The idea is that you have two theoretically unrelated funds that take
complementary positions with uneven odds. One sacrifices performance for the
other, effectively transmitting money. The trick, of course, is doing this in
a manner so that you have plausible deniability with regulators and, more
importantly, so that other market players don't grab the money in flight,
because that's what an efficient market would do. Still, consistently creating
and hiding complementary pairs of good/bad opportunities is a much easier
problem than consistently beating the market.

OK, so you've got a way to transmit money from a "sucker fund" to a "winner's
fund" with plausible deniability, what do you do with this ability? In reality
you'd probably have many "sucker funds," rotate the one that gets sucked, and
limit the extent to which it gets sucked, but still, nobody's going to just
buy the sucker fund, not for long, anyway. That's how efficient markets work.
Well, one major, well-known, boring inefficiency is the principal agent
problem: trusting others to invest your money. They can't just steal it,
because that's illegal. They can't just invest in a private fund that they
just happen to oversee and which just happens to pay them an enormous salary,
because that's illegal. However, if they were to invest in one side of a money
wormhole, which is designed to look like a perfectly reasonable investment on
its own, in exchange for a cut of the proceeds from the other side of the
money wormhole, who's to say the theft even happened? Such an accusation would
need to untangle the coordination behavior of the money wormhole to make its
case, and those inner workings could be made very convoluted indeed, hidden
deep inside complementary pseudorandom behavior.

So, in short, the conspiracy theory says it's a heist -- but one that's well
hidden under the veil of statistics and plausible deniability. It provides
investment managers looking to monetize the confidence placed in them a way to
make that happen without getting caught.

It's probably a dumb theory, but it's enough to entertain someone who knows as
little about finance as I do :)

~~~
SamBam
I'm not sure I understand your suggestion.

So there are (simplistically) two funds, Sucker and Winner. They take
complementary positions, and, whichever one wins gets transferred to Winner.

So far so good. Winner is winning every bet, and Sucker is losing every bet.

Now you need people to put money into Sucker, because it has to come out the
other end into Winner. How do you convince them to do that? By giving them a
cut of Winner's profit?

But that's where things don't add up. How can the Sucker investors and the
Winner investors both be making a profit from Winner's funds, if the net money
going in and out of the combined funds is equal?

~~~
Mvandenbergh
People with illegally earned money put their money into a series of short
lived sucker funds which exist to funnel money invisibly into the winner fund
where it reappears as legitimate investment returns. The dumb version of this
with very simple mirror trades which were easy to track has been seen "in the
wild" in Russia as carried out by people at DB.

BTW I don't really buy this theory but that's how it would work.

~~~
james-imitative
This has been happening in Peru, Uganda, Bolivia and Grenada.

------
leto_ii
> The Medallion fund has been closed to external capital since 1993, and
> analysis of the flagship fund’s annual returns suggests that significant
> distributions are made each year to keep the fund about the same size. For
> example, despite the fact that Medallion reported annual net returns above
> 29 percent every year between 2010 and 2018, the fund’s assets under
> management stayed at about $10 billion throughout that period.

This suggests to me that whatever opportunities they're exploiting, they would
vanish quickly if they would increase the fund's size (e.g. by compounding
returns).

It's worth taking a look at the Numberphile interview with Simons
([https://www.youtube.com/watch?v=QNznD9hMEh0](https://www.youtube.com/watch?v=QNznD9hMEh0)).
There he suggests that they're mostly using ML and other relatively simple
techniques, with a bit of more advanced math when it comes to predicting how a
trade will move the market. This chimes in well with the idea that they have
to keep their trades relatively small in order to remain this profitable.

------
jkhdigital
As the article hints at, Medallion isn't really an investment fund so much as
a pool of capital which is employed in the business of providing tactical
liquidity to markets. This is a business where one's competitive advantage
rests upon their technological advantage, and Renaissance has been
exceptionally adept at building and maintaining that advantage.

The EMH is a theoretical concept that must be tempered to account for the
frictions inherent in reality. As my PhD advisor likes to say, "all models are
wrong; some are useful." Liquidity is a major friction in real-world markets,
and providing liquidity (i.e. a means of moving capital into and out of
specific assets) is a service that is compensated accordingly.

In other words, I think Renaissance is simply better than anyone in the world
at finding the markets where traders are willing to pay the highest premiums
for liquidity, and providing it in a timely and measured dose that ensures
they skim the cream off the profit opportunity. There are a limited amount of
such opportunities, so they must limit the amount of capital employed to
maintain the high rate of return.

~~~
macspoofing
>Renaissance is simply better than anyone in the world at finding the markets
where traders are willing to pay the highest premiums for liquidity, and
providing it in a timely and measured dose that ensures they skim the cream
off the profit opportunity.

Why are they better?

This still requires the same kind of explanation as 'they are simply better at
investing than anyone in the world'

~~~
logicchains
>Why are they better?

Possible explanation: there aren't any other firms founded by as great
mathematicians as the founders of Renaissance. I saw a quote online attributed
to them, something like: "We hire the A-grade mathematicians. Most other firms
hire B and C grade mathematicians, and don't even know the A grade exists".
This fits my experience, as a D-grade mathematician working in finance. Never
heard of significant mathematical prizewinning researchers working at any of
the firms I know (lots of maths olympians, but there's a huge difference
between winning a maths olympiad and conducting groundbreaking mathematical
research).

~~~
hogFeast
This is only half of it. If you look at all their early employees, Robert
Frey/James Patterson have profiles, they were people who knew the maths AND
knew how to apply it.

If you look at AHL, they have lots of people who know the maths. They have
their own institute at Oxford ffs (the number of people who don't have PHds
from Oxbridge there is small), and they have crap performance, year-in, year-
out.

It is a typical flaw of human nature to assume that when someone else does
something extraordinary that they have some secret knowledge you don't. People
on here talking about discrete topology and all kinds of craziness...read the
book, one of the big early advantages that RenTech had was they sent some guy
down to the Fed to transcribe by hand data that no-one else had. Another
example is their stat arb strategy didn't work for years, until they worked
out how to get good execution.

I am not saying that it is only this but if you read the book, there are
several instances where RenTech try to apply something complex and it doesn't
work...and the success they have is after doing something simple, marginally
better than anyone else...again, to a certain kind of person, this simplicity
is offensive but it is also why most people with technical backgrounds get
destroyed by the market.

Also, one thing that is kind of unclear. Simons had almost nothing to do with
the perf. By the early 90s, he wasn't personally active anymore (he was
spending most of his time on venture capital). The step change was hiring
Brown and Mercer (again, two guys who clearly knew the maths but had spent
most of their time in industry). Ppl assume that Simons is in the boiler room
doing all kinds of crazy technical stuff...he wasn't (most of the time that he
ran the fund, it didn't do well at all).

~~~
perl4ever
"this simplicity is offensive but it is also why most people with technical
backgrounds get destroyed by the market"

Figuring out things nobody else can is the hard way to achieve. Figuring out
what you _don 't_ know and never betting on it is an alternative way that
doesn't require being a genius.

~~~
hogFeast
Just my 2c, and this is more based on my experience academically, almost no-
one figures things out that nobody else can. Innovation is largely a
combination of circumstance and timing. Some ideas just have their time.
Having unrealistic expectations around this is part of the problem (AHL went
in thinking they could just hire a bunch of "boffins"...but they are all
average, they just have PHds or whatever).

I don't think it is only knowing what you don't know either. That is a
component but people from academia are rarely overconfident, the opposite is
usually true (they tend to react badly under pressure). These people have a
"circle of competence", they know what they don't know...but they don't really
have anything else. All these places are churning massive resources into
education, into human capital...is that working? It clearly works in some
places and not others. I am just very cautious of the "know what you don't
know" argument because it tends towards thinking everyone should be
specialists...and I don't think the world works that way.

~~~
perl4ever
Knowing what you don't know doesn't correspond to a level of confidence or
humility, in the way I meant it.

You can have low confidence and discount the value of things you know, while
still assuming you know things you don't.

------
scottious
I'm no finance expert but doesn't this all seem way too good to be true? At
first I was reading this and thinking "how is this not exactly like Bernie
Madoff?"

Then they say "The Medallion fund has been closed to external capital since
1993 ... whatever profit they make, they pay out". So clearly it can't be a
ponzie scheme?

Still, it seems too good to be true. If financial experts are stumped as well
then that also seems like a red flag.

~~~
huffmsa
I don't think they could keep it up for that long without slipping up at least
once. Enron started around the same time and got tripped up in 2001.

If it were a one man investment shop, then maybe it leans more towards fraud.
But if they obviously employ dozens of quants, and have obvious hardware
outlays, it seems less likely.

It makes a lot of sense to me that they just win a bit more than they lose,
play a lot of hands, and treat everything with pretty even money, so they're
never overexposed in any one place.

~~~
huffmsa
I think I have the math right here, but let's say you start with > Capital =
$100

1 time a day 5 days a week 50 weeks a year, you're going to take your capital
and place that many $1 bets with it.

Let's say you net +1% on your deployed capital ever day.

After 250 rounds, you have $1215 in the bank.

Again, correct the math if I'm wrong. But scale that down to 0.57%, which is
the win rate I saw, and they're making ~$600/yr, which is the stated average
return.

Seems legit

~~~
papln
> Let's say you net +1% on your deployed capital ever day.

That's the "..." step in "1 steal underpants, 2 ..., 3 Profit!"

~~~
huffmsa
Well yeah. But that's what they've figured out.

It's unlikely, but not impossible.

------
PaulVYoung
Considering the motivations from the various points of view....

As an investor, I’m going to discount anything I can’t invest in and just
focus on the numbers of the open fund. These closed flagships are a common
marketing approach. Like concept cars, they grab attention and help sell the
more mundane models that are commercially viable. This article being a good
example. Clearly it works in this role and I can understand why they would do
this.

As a PM, I’d always prefer to have my own capital in a closed flagship where I
can cherry pick the best strategies, charge myself less fees and make use of
the latest tech and R&D subsidised by the open funds. My reporting
requirements are much less onerous so there is plenty of scope to massage the
numbers too.

As a regulator, I’m underfunded and politically motivated to focus on high
profile cases where large numbers of everyday public (voters) have been ripped
off. I have little time for institutional investors who should know better and
so closed funds trading internal money are way down my list.

As a regTech founder, I’ve seen plenty of examples of creative methods to get
around regulations. Or they just being blatantly ignored. Compliance are
usually colluding and helping coverup. Insider trading is one of the higher
risk methods, to get these sort of returns it would be easier to simply get
access to the “dumb” order flow from the open funds. Using lots of fancy
looking algos etc. to hide simple front running.

Given they are closed and trading their own money we are only going to know
what they choose to disclose. Personally, I’d bet on this being legit, given
the figures while great, aren’t impossible given the privileged position they
have in terms of access, information, tech etc. And the existing distribution
of performance for low capacity HFT strategies. People abusing the system
would be making even more and keeping quiet about it.

------
orbifold
My long standing hypothesis on Medallion is that they figured out how to apply
gauge theoretic techniques to financial markets. This fits with Simons work
that he did before he founded the fund. The fact that gauge theory is
applicable to for example currency trading is folk knowledge in the Havard,
Princeton, IAS circles (here is for example the lecture notes of a popular
lecture by Maldacena that uses currency trading as an example of a gauge
theory
[https://arxiv.org/pdf/1410.6753.pdf](https://arxiv.org/pdf/1410.6753.pdf)).

In currency trading example the curvature $F$ of the gauge connection $A$
vanishes precisely, when there is no arbitrage opportunity. Now what Chern and
Simons discovered is a differential form K
([https://en.wikipedia.org/wiki/Chern–Simons_form](https://en.wikipedia.org/wiki/Chern–Simons_form)),
which when taken as the action S(A) of a gauge field $A$, has a corresponding
field equation $F = 0$ (i.e. in the finance case = no arbitrage). In these
equations time does not enter, however there are several ways in which on can
incorporate time into the picture (for a naive example see also the lecture
notes). Assets in this framework live in associated vector bundles of the
principal bundle defining exchange rates.

My speculative assertion is that it is possible to identify "topological
invariants" which can be computed by sequences of trades, i.e. parallel
transport along the gauge connection and that those can have provably positive
expected return. The fact that the fund is limited to a small amount of
invested capital might be related to the fact that the strategies require
measurements, that would have self-interactions if they were too large.

~~~
dcolkitt
> My long standing hypothesis on Medallion is that they figured out how to
> apply gauge theoretic techniques to financial markets.

No. Listen to the Talking Machines podcast with Nick Patterson (who was a
senior VP in research at RennTech for a long time). To paraphrase he says that
the vast majority of their strategies are no more than simple linear
regression. The challenge is that even though regression is conceptually
simple it still takes smart people to answer questions like "what should you
be regressing", or "should you apply any transform" or "how should you clean
your data" or "do you understand the process well enough to realize when
results are obviously unrealistic".

The thing that makes a firm like Renaissance a league above a firm like Two
Sigma is the same thing that makes Two Sigma a league above a firm like
Winton. It's not mathematical gnosticism, it's plain old operational
excellence. It's things like expansive reliable curated datasets, deep
expertise on market structure, good execution systems, powerful research and
backtesting software, good access to markets, economies of scale, talented
practitioners, and excellent organizational management.

~~~
orbifold
The assertions you make are not necessarily in contradiction to what I am
saying. In discretised form most of the formulas I'm talking about boil down
to simple linear algebra with unknown parameters. You can then use essentially
linear regression to find those parameters, based on observed market data and
trades you are making.

So I was talking about the "what should I be regressing" and "transformation"
(you can use gauge theory to adjust for inflation and changes in exchange rate
in non-obvious ways) part. There is no question that having access to enough
data and operational excellent are a complementary component.

------
Tycho
Seems to me there's an obvious flaw in the efficient market hypothesis. It
states that, essentially, you can find no sustainable edge because the market
rapidly reacts to information. Meaning, if there is some information relevant
to expected investment performance, investors will immediately act on it,
extinguishing the information advantage.

But what if the opportunity is some kind of abstract pattern that doesn't make
any sense to humans? You can hardly say that people would efficiently react to
patterns that are entirely uninterpretable to them. So it leaves the door open
for these sort of statistical artifacts - abstract side-effects or unintuitive
properties of the overall system - to provide a sustainable source of alpha.

~~~
dcolkitt
The efficient market hypothesis is a lot like Newtonian gravity. It's not a
perfect theory, but it's a pretty close approximation that pretty much covers
most any domain outside very exotic conditions.

If somebody comes up to you, a random Joe Schmoe, and tells you they have an
investment that consistently beats the market on a risk-adjusted basis.
Well... You can pretty much guarantee that they're full of shit.

Even just analyzing papers that passed the rigor of academic peer review, the
sizable majority of market anomalies fail to replicate on an out-of-sample
basis[1].

Like Newtonian gravity, to the extent that deviations exist it's either of
very small magnitude or in very exotic conditions. The market anomalies that
do exist, like the HML value effect or momentum effect, don't substantially
improve the optimal portfolio and go through very long periods of deep
drawdowns.

Or in the realm of the very exotic, there are small teams, in aggregate making
up much less than 0.1% of the market, that do consistently out-perform. There
common characteristics of these strategies are that they have tightly limited
capacity, involve a huge up-front investment in technology and expertise,
almost never offer to manage outsider money, and are extremely hard to
replicate even by other experts.

[1] [https://www.nber.org/papers/w23394](https://www.nber.org/papers/w23394)

~~~
Tycho
If the value and momentum and size factors are legitimate, then it stands to
reason that there could be other more obscure, less intuitive and more
profitable anomalies. Are those limited to very small magnitudes? Maybe, but I
don't see why that should necessarily be so. It seems like EMH is predicated
on the idea that the only investment opportunities are ones that map to human
reasoning.

------
scotty79
There are two simple explanations for this:

\- somebody lies.

\- one out of hundres of thousands may seem (and be) incredibly lucky for
quite long. Until it isn't.

With the amount of transparency involved in this case for all I know they
could be just laundering money for mafia by doing too many transactions that
anyone could ever audit and claiming profit on them.

It's way easier explanation than "random walk is not random" and even easier
than "they got 30 years of luck on random walk where second best got 5 or
sth." which still is not so implausible as the first one.

------
nabla9
The explanations given in the article are good ones and are said before. Even
in HN
[https://news.ycombinator.com/item?id=13033733](https://news.ycombinator.com/item?id=13033733)

They have a strategy that does not scale beyond certain limit and they keep
the fund tightly within those limits.

------
hogFeast
Asking a finance professor about a hedge fund is like asking someone from the
1850s how a car works. Wrong tools. Wrong knowledge. Wrong way of thinking.
Like he is talking about EMH...lul, it is just fiction.

------
bhouston
Madoff has unexplained gains year over year as well based on new methods.

The explanation as offered triggers me but I haven't looked into it in detail.

For Madoff the gains were truly magical as there was little evidence he
actually traded.

Interestingly, Epstein supposedly has magical gains as well with little
evidence he traded.

------
nateburke
How big are the external funds? If they are large enough, it wouldn't be hard
(quantitatively) to shave a percent or two off of their returns in bad
medallion years to keep the winning streak alive.

The inflows inspired by the mystique shrouding medallion alone could make this
easy

~~~
hhmc
There are strict regulatory obligations to the outside investors that would
make that transfer illegal.

~~~
scottious
illegal, sure. But let's say there are some very bad actors involved... would
it be possible? People have been known to do illegal things in finance and
have tried to cover their tracks in the past.

~~~
hogFeast
Nope. This used to be quite common in the 80s (you would run a public fund,
and allocate losing positions to pension funds) but doesn't happen today.

------
analogkid
These comments are almost all a dumpster fire of clueless speculation. I
normally suggest people read Hacker News comments, but this is embarrassing.
The uninformed ramblings about winner v. sucker funds, or assertions of
insider trading are sad.

The only factual comment here was by MR4D about how IRA accounts can impact
wash sale rules, as would all accounts you own in prime brokerage.

Hint: maybe there is a high probability the author of this paper doesn't know
what he is doing. It wouldn't be the first time:
[https://www.latimes.com/business/hiltzik/la-fi-hiltzik-
corne...](https://www.latimes.com/business/hiltzik/la-fi-hiltzik-cornell-
verizon-20190219-story.html)

Or maybe he's selling a competing product: [https://cornell-
capital.com/about-2](https://cornell-capital.com/about-2) but can't compete.

------
fsckboy
the magic $10 billion number capping the size of the fund also seems curious
because why would it be impervious to change over a period of 25 yrs in which
the scale of trading volumes, market capitalization, etc. have all grown?

also, groups of people don't perfectly share ideas, outlooks, etc. especially
over time. Humans tend to argue, debate, tug of war. If this task (the puzzle
they are solving) requires a team of people, the 1st tiers and 2nd tiers,
again, how does that translate to a steady $10 billion "working capital"
portfolio and steady returns over 25 yrs, this money sucking tick
parasitically attaching itself to a stochastic market that has undergone vast
changes, but itself staying so consistent?

~~~
eigenvalue
I don't believe the size has in fact been constant. I remember reading years
ago that Medallion was capped at around $5 billion.

------
hash872
>Robert Mercer, the former co–chief executive of Renaissance Technologies,
allegedly told a friend that Medallion was right 50.75 percent of the time
when it came to its millions of trades — adding that “you can make billions
that way.”

Totally not a finance guy, but how can this be true with drawdowns? The losses
are worse than the gains- if you had $100 and take a 33% loss, it would take a
bit more than a 50% gain to get back to where you were. 50% loss and you'd
need to double your money to get back, etc.

So.... with drawdowns, don't you need to be right more than 50.75% of the
time?

~~~
tomp
No, you bet 100 x $1, win 50.75% of the time, so you make $1.5 in profit. Now
repeat 1bn times.

~~~
hash872
But if you're losing (undefined amount of money) on 49.25% of the trades....

------
musicale
If it looks too good to be true, it usually is.

------
cynusx
I have a much more simpler (not based on any evidence) theory which kind of
explains the founders' alignment with Russian interests.

Most of medaillon's returns are made with insider trading from hacking. The
data science part is just come up with explanations that are complex enough
and not easily disproven (e.g. find a correlating variable and explain that
you had a magic algo that derived prediction from that correlating variable
after the fact).

It's a perfect crime, but you would need to setup crazy incentive structures
for all the team members and their immediate family to keep it secret... and
that's what they are doing.

I would guess they used Russian hackers for the job, given that the fund is
heavily funding Russian political interests in western countries.

I would recommend the SEC to dive really deep with appropriate expertise into
this magic fund and double-check this simple theory of mine. Just for national
security reasons alone.

(note again: this is a conspiracy theory and not evidence or fact-based)

~~~
tehlike
Keeping something like this secret is... Hard.

~~~
SirLJ
NSA will know about this in a heartbeat

------
CPLX
The hedge fund business is and has always been based on insider trading.
Ockham’s razor looms large over this conversation.

~~~
smabie
If that were true, you’d expect that as a group they would have better risk
adjusted returns. I personally have not witnessed any insider trading in the
industry and suspect it quite rare nowadays. It was more common in the past,
though.

~~~
papln
Some hedge funds are good at it, and some are bad it. The existence of a
winnable game doesn't mean that everyone who attempts it will succeed.
Especially since the game is competitive, so if I have better insider
information than you, I can take from you you all the money you take from the
non-insider traders.

------
bawana
What are they talking about? Rentech went into the dumpster.

[https://seekingalpha.com/news/3300183-rentech-to-delist-
from...](https://seekingalpha.com/news/3300183-rentech-to-delist-from-nasdaq-
sharesminus-26)

~~~
duncancarroll
Doesn't look like that's the same Rentech:
[https://seekingalpha.com/symbol/RTK](https://seekingalpha.com/symbol/RTK)

"Owns and operates wood fibre and nitrogen fertilizer businesses"

------
codingslave
Investing is like tech, its winner take all. This is like being surprised that
Google dominates search

~~~
sweeneyrod
No, it's the exact opposite. The limit of how much money you can put through a
given strategy mean there is an antieconomy of scale that encourages lots of
small firms.

~~~
codingslave
this is the complete opposite of true. I work in the industry, too busy to
write up a response. But basically, the top five hedge funds are making most
of the returns and are attracting most of the capital. the industry is
consolidating

~~~
sweeneyrod
It's certainly plausible that the few best funds are outliers in terms of
return. And I'm sure they _attract_ a lot of capital in the sense that a lot
of people want to invest in them, but that doesn't mean they allow it. As far
as I can tell, the top 5 hedge funds by AUM have around 10% of the whole
sector's capital. In comparison, the top 5 tech companies in the S&P500 have
market caps summing to around 10% of the whole index (not just the tech
sector).

------
eaenki
The nasdaq 100 leveraged x3 on a daily basis returned like 50%+ YoY during the
last decade. And that’s an index. Buffet himself said he could return 50% YoY
consistently with a small(ish) amount of money. (He manages like half a
trillion)

there’s no reason why with $10B trading all asset classes one can’t return 70%
YoY. You must note that the fund is capped, the execution costs are incredibly
low and that over the last decade it returned less than 70% YoY.

~~~
relham
3x levered nasdaq 100 would give you an annual volatility of at least 30-50%,
occasionally much much higher. The crazy thing is that medallion presumably
achieved this with a very small volatility and no significant drawdowns.
Nasdaq 100 was down -42% in 2008, so levered 3x you would be out of business.

~~~
smabie
3x leverage ETFs rebalance daily, so you would still have some money since the
biggest single day loss of Nasdaq is ~10%.

~~~
tomatocracy
Incidentally this also means that if you buy the etf on day 1 and the
underlying is at 100, on day 2 the underlying falls to 99 then on day 3 goes
back to 100 then you would be left with less than 100% of what you started
with (assuming perfect tracking and no fees).

~~~
slumdev
Yes, this is called "decay", and it's why you don't want to hold a leveraged
fund over any long period.

~~~
smabie
According to my models there are very few market environments in which you
would make less money with a leverage ratio of 2.5x. In order maximize return
your leverage should be:

Expected Return/Expected Variance

For example even if the expected return is 1% and the vol 5%, the ideal
leverage ratio for maximizing return is 4x!

In short, a 2-3x leveraged ETF is an excellent investment and should
outperform the index in almost all market conditions. It’s when your leverage
ratio goes over 5x that you start to have major problems a lot of the time.

~~~
slumdev
I can appreciate this, but the fund decay actually has nothing to do with
leverage.

All "leveraged" ETFs (to the best of my knowledge) are synthetic - they
achieve their "leverage" using derivatives, not by borrowing. These
derivatives are not free, and like an option, can expire worthless. That's how
the value in these ETFs evaporates over time, regardless of how the market
performs.

~~~
smabie
Of course not “regardless” of how the market performs, take a look at UPRO
over the last 2/3 yrs. But those are in theory reasonable concerns, however
empirically most leveraged funds have performed as promised relative to their
benchmarks (with a couple notable exceptions I admit). The entire point of
derivatives (as suggested in the name) is that they inherantly bear an
underlying relationship to their underlying security.

If you look at UPRO, its daily returns almost exactly track 3x of SPY. There’s
no long-term “decay”, unless you are referring to volatility drag. VIX etfs
are the notable exception, in that they do suffer from persistant negative
carry.

