A new wave of single-value exchange-traded funds is sweeping the ETF industry.
So far, the ETF business has grown by primarily offering investors simple indices like the S&P 500, as well as more focused market segments like cybersecurity, clean energy, cloud computing and others. thematic games.
But now the ETF market is looking to grow by offering amplified bets on individual stocks.
Direxion and GraniteShares plan to roll out more than two dozen leveraged and inverse single-stock ETFs this year — and both have pending proposals before the Securities and Exchange Commission.
In February, Direxion filed 21 new ETFs, each offering exposure to daily or leveraged inverse returns from widely held names such as Facebook parent Meta Platforms, Nvidia, Netflix, Apple, Microsoft, Amazon and Alphabet. This filing followed AXS Investments‘ earlier push for leveraged funds.
These products aim to provide amplified means of using individual long or short names and will follow the typical leveraged ETF model – operating via a daily reset mechanism.
A daily reset suggests extremely short time horizons, as funds are reallocated or deleveraged each day. As Dave Mazza, chief product officer at Direxion, told CNBC’s “ETF Edge” this week, these ETFs are really for traders rather than investors.
“If someone doesn’t have the ability to monitor their portfolio to make a daily buy, sell or hold decision, this isn’t for them,” he said. “But it’s really a natural extension of the ETF market…And it’s a solution for the trading crowd.”
GraniteShares has also filed a series of leveraged and inverse ETFs in the United States. But the company isn’t new to the single-action game. It already offers a suite of more than 100 similar products, which have been trading in Europe for three years, allowing traders to go three times long or short names like Alphabet, Amazon, Apple, Facebook, Microsoft and Nvidia.
Will Rhind, CEO of GraniteShares, said these products have gained popularity overseas.
“I have to say it’s been very popular with investors,” he said. “There just aren’t many ways to accurately express short bets or long positions on single stocks as easily as an ETF package. And that’s what these products do for people.”
Rhind says the adoption rate is particularly high among a very specific type of sophisticated investor – someone who actively trades and is comfortable taking risks, especially when grappling with gains and amplified losses.
But with calls for more disclosure, Wall Street watchdogs like the Financial Industry Regulatory Authority and the SEC have cracked down on overly complex products.
SEC Chairman Gary Gensler has previously raised concerns about leveraged and inverse exchange-traded products – saying they can pose risks even to sophisticated investors and “potentially create scale risk.” of the system by operating in unexpected ways” – especially when markets are volatile or under stress.
Regulatory and commercial risks
So what are the chances of the SEC giving these products the green light?
It’s hard to say, but Rhind notes that the structure of these products has been around for many years – and investors have so far been very comfortable with the way they work.
Nonetheless, Dave Nadig, financial futurist at ETF Trends, says it’s important to recognize the potential contagion risks of trading such leveraged products.
“Imagine there were six, seven, eight different ETFs, all related to, say, Amazon,” Nadig said. “Does the Robinhood investor understand in a world where we have six or seven of these levers, or reverse plays on every major stock in the market? This is where it starts to get a little confusing.”
Mazza agreed that there is risk, but reiterated that these ETFs should not be treated as investments to hold. He also said he does not foresee any systemic risk from these products in the broader market.
“The structure of the ETF has proven resilient,” he said. “But at the end of the day, we’re really advocating for traders to understand how it works, especially around this daily reset mechanism.”
He noted that the implied holding period for these products is extremely short, “so for the most part people are using them appropriately.”
Rhind added that the ETFs he plans to launch offer a safer way to leverage than many traditional short-selling methods because traders will never lose more than their initial investment.
Of course, this comes at the expense of the higher fees required to continually rebalance these portfolios.
So in these turbulent market times, what exactly are traders buying these days?
Mazza mentioned three different mentalities: risk-on, risk-off and rotation.
- Risk on: Among Direxion’s most popular products are Direxion Daily Semiconductor Bull 3X shares (ticker: SOXL) – a basket of chip stocks that has accumulated more than $3 billion in assets under management. Mazza said flows in the semiconductor space have been strong, especially on days when the market is down.
- Abandonment of risk: Instead of selling individual positions in technology or financials, traders turn to inverse ETFs to provide daily hedging if they believe there is event risk, especially during earnings season.
- Rotary: Big money is flowing into oil and gas as crude prices soar, especially in the Direxion Daily S&P Oil & Gas Exploration and Production Bull 2X Shares ETF (ticker: GUSH), a leveraged vehicle on the energy sector.
Nadig stressed the importance of having brokers like Charles Schwab and Fidelity emphasizing disclosures to ensure investors really know what they are doing, which he says is inevitable as more increasingly complex products are coming to market.
The problem, of course, is that companies can offer a slew of disclosures, but there’s no guarantee investors will pay attention.
Ultimately, says Nadig, these are speculative vehicles used for short-term event trading that should not be viewed as portfolio building blocks.
“My concern is that these are very, very sharp tools,” he said. “And when people reach into the drawer, they don’t always look as carefully as they should.”
The SEC has approximately 75 days to respond to these proposals.