By Michael Wursthorn
Investors' penchant for risk-taking has rejuvenated a volatile
and sometimes dangerous group of exchange-traded funds.
Leveraged and inverse ETFs have raked in $16.3 billion through
the first 10 months of the year, on pace to top 2008's record haul
of $16.7 billion, according to Morningstar. The funds use leverage
to double or triple daily returns and sometimes offer investors a
chance to profit off the inverse, or opposite, of an index's
move.
Those features have proved popular in this year's stock market
rally. Stimulative efforts by the U.S. government to support the
economy have created a springboard for stocks to surge since the
market cratered in March. The S&P 500 has risen 13% this year
and is trading at record levels, despite falling as much as 34%
over five weeks in February and March
The hunt for bigger returns has led many investors to take bold
gambits that have the potential for big gains and even bigger
losses. More investors are using options than ever before to juice
returns, and some have gambled on bounces in the share prices of
bankrupt companies. Investors put more than $14 billion into
leveraged and inverse ETFs in March and April alone, when those
funds moved dramatically in tandem with the indexes they track.
"These products are ripe for investor attention," said Todd
Rosenbluth, head of ETF and mutual-fund research at CFRA. "People
see the strong performance and think, 'I want that too.' The market
environment is conducive to leverage, but investors should be very
careful."
Take the $8.6 billion ProShares UltraPro QQQ ETF, the biggest
leveraged ETF by assets. It triples the daily return of an index
that tracks the top 100 Nasdaq stocks and has nearly doubled in
value over the past six months. Investors rushed into the fund in
March and April, reversing several months of outflows. In
September, investors put nearly $2 billion into the fund, its
biggest month of inflows ever, according to Morningstar data.
Leveraged ETFs are designed to be held over the course of a
single trading session. For periods longer than that, investors
risk seeing returns, or even losses, that deviate from the
performance of the index the fund tracks. But eye-popping gains
over longer stretches tempt some investors to hold those funds for
months or even years, putting them at risk of suffering a severe
loss if that index plunges.
"If you're bullish about the S&P 500, then all the more
reason you should be bullish about a leveraged S&P 500 fund,"
said John Rossi, a 69-year-old retiree who says he has used
leveraged ETFs throughout the past decade. He favors
triple-leveraged funds that track the S&P 500 and the top 100
Nasdaq stocks, among others, saying the products have been reliable
contributors to his portfolio's performance.
A stretch of sharp volatility, such as the one in March, is
nothing more than an opportunity to buy even more shares of those
funds, he added. "You have to have a high risk tolerance to do
that," said Mr. Rossi, who estimates that about 30% of his
portfolio is in leveraged ETFs. "And the cash on the
sidelines."
But some long-term holders of leveraged ETFs have been burned in
dramatic fashion. Investors lost millions in 2018 after volatility
surged, saddling some leveraged funds and other exchange-traded
products with sudden, massive losses. Several leveraged
exchange-traded products blew up earlier this year after oil prices
fell into negative territory.
Those incidents raised questions about whether investors fully
understand the risks of the products.
For those reasons, some of the biggest players in the $5
trillion ETF industry say they have no interest in adding leveraged
products to their lineups, even after securities regulators opened
the door to greater competition.
Last month the Securities and Exchange Commission gave a blanket
blessing to new leveraged ETFs, ending its freeze on such activity
when it shelved a measure that would have required more-stringent
sales practices for such funds. Direxion and ProShares had
previously been the only firms with approval to market the
products. In a nod to the extreme volatility these products can
experience, the SEC capped leverage of new funds at two times.
Usually such an invitation from a regulator would lead to a rash
of new products, such as when the SEC greenlighted actively managed
ETFs last year. Not this time.
A spokeswoman for BlackRock Inc.'s iShares, the biggest ETF
manager by market share, said that the firm has given priority to
the rollout of sustainable investing and fixed-income funds, and
that it doesn't include any leveraged or inverse funds in its
product lineup.
Vanguard, the second-biggest player in the ETF space, banned the
purchase of inverse and leveraged funds from its brokerage platform
last year. A spokesman said that the restriction remains in effect
and that such products are "incompatible with our longstanding
buy-and-hold approach."
Invesco, another big player in the market, has no intentions of
jumping in at this time, said Anna Paglia, head of ETFs and indexed
strategies.
"We continue to believe that levered [and] inverse ETFs carry a
set of risks that are separate and distinct from the traditional
investment risk associated with ETFs," she added.
The positions of those three firms, which together control about
70% of the ETF market, aren't a surprise. They were part of a
consortium that petitioned the major stock exchanges earlier this
year for a new naming system that would prohibit leveraged and
inverse funds from using the ETF moniker. They argued that "ETF"
had become a blanket term for a range of products that can lead to
significantly different outcomes for investors.
Michael Sapir, chief executive of ProShares, said the firm has
given priority to educating investors on how the firm's leveraged
and inverse products work, and urges anyone buying such products to
do his or her homework beforehand. "They simply shouldn't buy them
if they don't understand the product," Mr. Sapir added.
CFRA's Mr. Rosenbluth says smaller competitors are more likely
to make a run at the leveraged-ETF market. But without the vast
resources of the industry's biggest players, such funds are likely
to remain the domain of the duopoly, he added.
"Firms that have the resources to compete with ProShares and
Direxion are focused elsewhere," Mr. Rosenbluth said.
Write to Michael Wursthorn at Michael.Wursthorn@wsj.com
(END) Dow Jones Newswires
November 29, 2020 11:14 ET (16:14 GMT)
Copyright (c) 2020 Dow Jones & Company, Inc.
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