Leveraged and inverse indices are widely used by investors looking for a measurement that magnifies performance or hedges against market downturns. For the Mexican equity market, S&P DJI provides market participants with an amplified or inverse view of the S&P/BMV IPC through the S&P/BMV IPC 2X Leverage Daily Index and S&P/BMV IPC Inverse Daily Index, respectively (see Exhibit 1).¹

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Introduction to Leveraged and Inverse Indices

Leveraged and inverse indices are designed to reflect multiplied or opposite daily performance of an index. For example, if the base index increases by 1% in a day, a 2x leveraged index would increase by 2%, while an inverse index would decrease by 1%.

These indices are often used in short-term investment strategies. Some asset managers use derivatives to replicate performance for their products. It’s important to note that the performance of these indices is measured daily and not cumulatively. They are rebalanced daily to maintain their leverage or inverse objective, which means returns are calculated from a new reference point every day. Over longer periods, especially during volatile market conditions, the performance of these indices can deviate significantly from their initial targets due to the compounding effect.

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As shown in Exhibit 2, while the S&P/BMV IPC returned a cumulative 15% during this period, the S&P/BMV IPC 2X Leverage Daily Index underperformed the S&P/BMV IPC by more than 10%, and the S&P/BMV IPC Inverse Daily Index dropped around 30%. Due to the compounding effect and volatility, the return of the leveraged and inverse indices deviated significantly from their target at the end of this period

Case Study: The Hypothetical Performance of S&P/BMV IPC Leverage and Inverse Indices during High Volatility Periods

The below case study analyzes the performance of these indices during episodes of high volatility through a hypothetical index. A hypothetical index that assigns a 10% or 20% weight to the S&P/BMV Daily Leverage 2x or Inverse Indices during periods of high volatility and the broad Mexican equities market, as represented by the S&P/BMV IPC, are used for this purpose.

There were four short-term periods of sustained high volatility, defined as episodes where the annualized volatility of the S&P/BMV IPC was over 20% for more than 20 trading days (see Exhibit 3). For this analysis, we will focus on the second episode in 2018.

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At the end of this second episode (from Nov. 1, 2018, to Dec. 24, 2018, around the inauguration of Andres Manuel Lopez Obrador as president of Mexico), the S&P/BMV IPC had negative performance of 5.83% for this two-month period. The hypothetical index that blends the S&P/BMV IPC and one of its leveraged/inverse indices demonstrates that even a small allocation to leveraged and inverse indices has the potential to significantly affect risk and return. For this same two-month period, the hedged blend would have demonstrated improved performance and reduced risk, while the leveraged blend would have amplified losses and volatility.

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The case study above can help illustrate the hypothetical effects of leverage and compounding in the performance of leveraged and inverse indices. For the Mexican equity market, S&P Dow Jones Indices offers the S&P/BMV IPC 2X Leverage Daily and S&P/BMV IPC Inverse Daily Indices. However, due to the compounding effect and market volatility, the performance of these indices may deviate from their targets over longer periods.

¹ For more information, please consult the S&P/BMV Indices methodology document.

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