The Rise of Leveraged Single Stock ETFs: A Warning Sign for the Market?
As the market continues to soar to new heights, a peculiar trend has emerged: leveraged single stock ETFs are booming. These funds, which offer retail investors magnified exposure to individual stocks, have hit a record $17 billion in trading volume. But is this surge a sign of investor euphoria, and what does it mean for the market?
A Growing Concern
Todd Sohn, ETF strategist at Strategas, notes that the growth rate of leveraged single stock ETFs is curious, especially given that equities are trading at an all-time high. Typically, trading volume in these funds would spike during market downturns, not during a bull market. Sohn warns that this popularity could be a warning sign about sentiment among investors.
A “Gambling Mentality”?
Daniel Sotiroff, senior analyst at Morningstar, agrees that the rise of leveraged funds is indicative of a “gambling mentality” in the market. He advises investors to avoid these funds altogether, citing concerns about their design and performance.
The Problem with Volatility Drift
One of the biggest concerns around leveraged funds is that they are only designed to meet their stated return on a daily basis. Over longer time horizons, investors can expect these funds to underperform their stated goals due to volatility drift. But recent issues with MicroStrategy-linked funds have surfaced a different problem: these funds are struggling to track the volatile crypto-linked stock even on a daily basis.
The Struggle to Track MicroStrategy
Return data shows that two major leveraged long MicroStrategy funds had multiple trading sessions where their return differed from the stated goal by more than 2 percentage points. The funds typically use swap agreements from banks to lock in leveraged exposure, but recent high demand and volatility have led to a shortage of swaps. As a result, the funds have turned to options to generate leverage, which could make it more difficult to achieve their goals.
A Growing Market
Despite these issues, the single stock ETF boom continues to grow. New funds are being launched, offering leveraged exposure to stocks like Novo Nordisk. But as the market continues to evolve, investors would do well to exercise caution and consider the potential risks of these funds.
The Bottom Line
The surge in leveraged single stock ETFs may be a sign of investor euphoria, and it’s essential to approach these funds with caution. While they may offer exciting returns, they also come with significant risks. As the market continues to shift, investors must stay vigilant and consider the potential consequences of their investment decisions.
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