Episode 397: Hendrik Bessembinder - Constant Leverage & Measuring Investor Outcomes - Rational Reminder Recap

Podcast: Rational Reminder

Published: 2026-02-19

Duration: 1 hr 6 min

Guests: Hendrik Bessembinder

Summary

Hendrik Bessembinder discusses the complexities of leveraged ETFs and introduces the concept of sustainable returns, challenging traditional return measurements for better financial planning.

What Happened

Hendrik Bessembinder returns to the podcast to discuss his latest research on leveraged single-stock ETFs, which often underperform compared to their levered benchmarks due to daily rebalancing and embedded costs. Long leverage stock ETFs underperform by approximately 0.79% per month, translating to an annual underperformance of over 9%. Short levered ETFs fare even worse, underperforming by 1% monthly or 12% annually. Bessembinder unpacks the concept of 'volatility decay', explaining that volatility can amplify returns depending on market trends and that daily rebalancing can lead to varying outcomes based on whether the market experiences continuation or reversals.

The conversation explores practical guidance on the use of leveraged single-stock ETFs, emphasizing their suitability for short-term strategies or strong directional views due to their inherent risks. Bessembinder also highlights the high rebalancing costs, especially in short ETFs, and the potential for catastrophic losses with returns occasionally dropping below -100%. Simulations over 50 years reveal that periods of high volatility align with market reversals, further dragging down performance.

In the second half, Bessembinder challenges traditional performance metrics like arithmetic and geometric means, arguing they don't accurately reflect long-term investor experiences. He introduces the 'sustainable return', a measure focused on the cash flows an investment can support without depleting its capital, which could transform academic finance and practical financial planning. The sustainable return relates closely to the geometric mean but provides a more realistic measure of what can be withdrawn from an investment over time.

Bessembinder explains that the sustainable return often shows more than half of individual stocks have negative values, highlighting the skewed distribution of stock returns. This concept aligns with John Cochran's idea of measuring investments based on the series of cash flows for retirement planning. Bessembinder suggests that future research should focus on aligning investment portfolios with cash flow needs rather than solely on portfolio value.

The episode also touches on the limitations of arithmetic means and single-period models, noting that aggregate investors typically do not reinvest dividends like buy-and-hold investors. Bessembinder argues for the use of dollar-weighted returns or modified IRRs, which better account for cash flows in and out of investments, reflecting actual investor behaviors.

Resources like Morningstar's 'Mind the Gap' series are mentioned as practical applications of dollar-weighted returns. Bessembinder plans to update his study on levered ETFs using recent data from CRISP and notes that high fees and frictional costs can significantly impact returns, drawing attention to the need for cautious use of these financial instruments.

Key Insights

• Leveraged single-stock ETFs, like those studied by Hendrik Bessembinder, often underperform their benchmarks due to the mechanics of daily rebalancing and embedded costs. Long leverage stock ETFs lag by approximately 0.79% monthly, equating to over 9% annually, while short levered ETFs suffer even more with a 1% monthly underperformance.
• The concept of 'sustainable return' challenges traditional metrics like arithmetic and geometric means by focusing on the cash flows an investment can support without depleting its capital. This approach, introduced by Bessembinder, offers a more realistic measure for long-term financial planning, contrasting with the typical focus on portfolio value.
• Bessembinder's insights reveal that more than half of individual stocks show negative sustainable return values, indicating a skewed distribution of stock returns. This finding aligns with John Cochran's idea of assessing investments based on cash flows, which could reshape retirement planning strategies.
• Traditional single-period models fail to account for real investor behavior, as aggregate investors often do not reinvest dividends like buy-and-hold investors. Bessembinder advocates for dollar-weighted returns or modified IRRs, which better reflect actual cash flows and provide a clearer picture of investment performance.

Key Questions Answered

What are leveraged single-stock ETFs according to Hendrik Bessembinder?

Leveraged single-stock ETFs are financial instruments that aim to amplify the returns of a single stock by using leverage. However, they often underperform due to daily rebalancing and embedded costs, making them suitable primarily for short-term strategies.

How does Bessembinder define sustainable returns?

Bessembinder defines sustainable returns as the measure of cash flows an investment can support over time without depleting its capital. This concept challenges traditional return metrics and could reshape both academic finance and practical financial planning.

Why are arithmetic means considered insufficient for long-term investor outcomes?

Arithmetic means do not accurately capture the multi-period outcomes that investors experience over the long term. Bessembinder suggests that they are not a realistic reflection of aggregate investor behavior and should be supplemented with metrics like dollar-weighted returns.