Sustainable leveraged investing through volatility management

Takahiro Imai

Abstract

Leveraged market exposure (via exchange-traded funds, derivatives or portfolio leverage) has become increasingly common as investors seek to increase exposure to market risk premiums. However, fixed-leverage strategies are particularly vulnerable to volatility drag and large short-term drawdowns, both of which can substantially impair long-run compounded returns. This paper examines volatilitymanaged leveraged portfolios through a risk-based Kelly framework, in which the conditional Sharpe ratio is assumed to remain approximately stable while volatility varies over time. Under this interpretation, inverse-volatility scaling shares the time-varying functional form of growth-optimal leverage without requiring direct forecasts of expected returns. By reducing exposure during turbulent markets and increasing it in calmer periods, volatility management adjusts leverage systematically in response to observable changes in market risk. Using futures data from nine markets spanning equities, government bonds and commodities, we compare volatility-managed portfolios with constant-leverage benchmarks matched by average exposure. Volatility management does not systematically increase long-run geometric returns, but it generally reduces realized portfolio volatility and the dispersion of long-run geometric-return distributions. The magnitude and statistical significance of the reduction in outcome dispersion vary across markets and specifications. The results remain broadly similar across alternative volatility targets, volatility estimators, transaction-cost assumptions and bootstrap block lengths. These findings suggest that volatility management provides a simple, transparent and implementable leverage-sizing framework that may support more stable and sustainable long-horizon leveraged investing.