Drag refers to the underperformance of a fund that attempts to replicate the return of a certain underlying. This drag is a long-term result of the daily portfolio rebalance that takes place. An underlying that shows this drag is VXX.
VXX is comprised of front and back month futures contracts that are balanced daily. When the /VX front and back month futures are in contango (this is the case a majority of the time), then the front month future is trading at a discount to the back month future. This results in the front month future being sold for less than what the next month future is worth. Since the back month futures trade higher than the front month futures, the fund cannot buy as many contracts as it sells. Rebalancing the portfolio daily, when in contango, results in a decrease in value over time.
The presence of drag in leveraged products makes them very unattractive for long-term holds to the long side. These products are meant to provide advantages to investors on a daily basis, not over longer periods of time.
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