Navigating the Complex Landscape of Leveraged Single-Stock ETFs
Financial Advisor IQ
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Last week, fund shop?AXS?unified its suite?of leveraged single-security exchange-traded funds under the new?Tradr?brand and quickly filed to launch 50 more such products, dubbed 2x funds.
They will join Tradr's existing suite of ETFs that offer leveraged or inverse exposure to single securities such as tech companies?Nvidia?and?Tesla?as well as?Ark Invest's flagship innovation ETF.
Leveraged single-stock ETFs borrow money to dial up their exposure to the reference stock, amplifying the stock's daily performance by factors such as 1.25x, 1.5x or 2x. Inverse strategies can also be leveraged using the same multipliers with a negative sign in front of them.
So, when Nvidia soared 16.4% on Feb. 22,?GraniteShares'?2x Long NVDA Daily ETF gained 32.4% and GraniteShares' 2x Short NVDA Daily ETF lost 33.6%, according to?Morningstar.
That's all well and good for traders who buy and sell the ETFs within a day, but investors who hold the ETFs for longer might find themselves in a pickle.
To use a simplified example from Morningstar, imagine a $10 stock that loses 10% one day (falling to $9) and gains 11.1% the next, finishing at $10 for a net return of 0%. If you double the action for the same $10 stock, you end up losing 20% on day one ($8) and gaining 22.2% on day two, finishing at $9.78 for a negative 2.2% return.
AXS was the first firm to offer single-stock ETFs after receiving approval from the?Securities and Exchange Commission?in July 2022 to offer bull and bear versions of ETFs tracking companies such as?Boeing,?Nike?and?Salesforce.
The new brand makes sense for AXS as managers look to differentiate ETFs meant for traders and not buy-and-hold investors,?Daniil Shapiro, director of product development at?Cerulli Associates?told Financial Advisor IQ sister title Ignites. Doing so would underscore the benefits of the products to traders while protecting people who such exposures aren't meant for, he said.
Tradr's competitors in the leveraged ETF space include?Direxion,?RexShares?and?Tuttle Capital Management.
The single-stock ETF space currently has?$7.4 billion in combined assets?across 59 ETFs, but $5.3 billion sits in ETFs that track two companies: Nvidia and Tesla.
The broader leveraged ETF space is similarly concentrated, with $32.2 billion in?ProShares?ETFs that track?Invesco's QQQ ETF. Overall, there are $111.2 billion in assets in the space, Morningstar data shows.
Revolving Door
Since investors clearly prefer leveraged exposure to just a few stocks and funds, it should come as no surprise that the space is rife with new launches and liquidations as issuers throw anything at the wall to see what sticks.
Less than a year after AXS became the first firm to launch single-stock ETFs, AXS?shuttered?five of the eight such ETFs it offered at the time. When AXS announced the liquidations of its?Pfizer, Nike and?PayPal-tracking ETFs in May 2023, the five ETFs had amassed just $6 million in assets combined.
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"[I]f the underlying stock fails to capture the attention of investors, the single-stock ETF will sit there and bleed cash covering operating costs,"?ETF Store?President?Nate Geraci?told Ignites at the time.
Handle with Care
Leveraged and single-stock ETFs have been rife with controversy since they first hit the market.
Leveraged as well as inverse exchange-traded products are designed to be held for just short periods of time, such as a single day or month, the?Financial Industry Regulatory Authority?warned in 2009. The self-regulatory organization in the years since has brought several actions against broker-dealers and reps over leveraged and inverse ETP recommendations.
Lori Schock, director of the SEC's office of investor education and advocacy, issued a statement about the "unique and complex" risks of single-stock ETFs when they were first approved in 2022, noting the short time frame these funds are designed to be held.
Schock pointed to how some single-stock ETFs aimed to provide returns within a day, warning that "new risks may emerge for investors who hold these products for longer than that."
In December of that year, the?North American Securities Administrators Association?and the?Consumer Federation of America?issued similar warnings about the potential dangers of the products.
Last June, the SEC's Investor Advisory Committee said the regulator should require brokers to provide additional warnings and disclosures about certain novel ETFs and ETPs at the point of sale. The committee also recommended single-stock ETFs?be renamed?because they don't have the diversified qualities of other ETFs or ETPs.
In March,?Dalia Blass, former director of the SEC's Division of Investment Management, told Ignites that she believed the SEC?should not require additional disclosures?or restrict the products. Instead, the regulator should focus on making sure the product lines up with how the ETF should function, she said.
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