Risky ETFs get a new lease on life

Investors hunting for huge returns are pouring money into high-return strategies that come with disproportionate risks

Risky ETFs get a new lease on life

A volatile and potentially dangerous variety of ETFs are seeing renewed interest as return-hungry investors display a greater sense of adventure.

Citing figures from Morningstar, the Wall Street Journal reported that inflows into inverse and leveraged ETFs for the first 10 months of 2020 amounted to US$16.3 billion, putting them comfortably on track to exceed the US$16.7 billion annual inflow record set in 2008.

“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 Journal said, noting a 13% rise in the S&P 500 this year that came despite the index nosediving by as much as 34% over five weeks in February and March.

The desire for juiced-up returns has pushed many investors into risky bets that offer big prospective gains in exchange for bigger potential payoffs. Aside from rising prevalence in the use of options, individual investors have shown some willingness to gamble on bounces in the share price of bankrupt companies.

The appetite for leveraged and inverse ETFs reached stratospheric levels in March and April alone, with over US$14 billion going into such funds as they moved drastically in tandem with the indexes they’re linked to.

“People see the strong performance and think, ‘I want that too,’” Todd Rosenbluth, head of ETF and mutual-fund research at CFRA told the Journal. “The market environment is conducive to leverage, but investors should be very careful.”

The US$8.6-billion ProShares UltraPro QQQ ETF has nearly doubled its value over the past six months, cementing its status as the largest leveraged ETF by assets. A flood of investors in March and April broke a several-month outflow streak; in September, the fund took in nearly US$2 billion, marking its biggest-ever month of inflows.

While leveraged ETFs are generally too radioactive to hold for more than a single trading session, hot streaks in the markets can seduce investors into keeping them for longer. “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,” 69-year-old retiree investor John Rossi said to the Journal. He said periods of sharp volatility, such as in March, present a chance to snap up more shares of leveraged ETFs, adding that it would take “high risk tolerance” as well as “cash on the sidelines.”

Not every investor sees a happy ending. A 2018 surge in volatility cost investors millions as it saddled some leveraged funds and ETFs with drastic losses. A dip in oil prices that pushed them into negative territory earlier this year also tanked several leveraged ETFs.

Experiences such as those have left investment managers cagey about having leveraged products on their shelves. Despite the U.S. Securities and Exchange Commission ruling that ended a freeze on leveraged ETF activity last month, spokespersons from BlackRock, Vanguard, and Invesco all told the Journal that they are not prioritizing the introduction of new levered and inverse products.

ProShares CEO Michael Sapir, whose firm was one of only two with approval to market the products before the SEC ruling, said the company is making it a priority to educate investors on how its leveraged and inverse products work, and encouraging them to do their due diligence before buying such products.

“They simply shouldn’t buy them if they don’t understand the product,” Sapir said.


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