Single-stock exchange-traded funds launched in the U.S. in July, offering investors leveraged exposure to one stock at a time.
AXS Investments debuted eight ETFs that allow investors to use leverage or make inverse bets on companies, such as Tesla, Inc., Nvidia Corp. and PayPal Holdings, Inc. Other ETF providers such as Innovator ETFs recently launched a single-stock ETF, and a few other companies such as Direxion and GraniteShares Advisors have expressed interest in issuing these funds.
After trading in Europe for more than a decade, these more complex ETFs are now making their debut in the $6.2 trillion ETF market in the U.S. Although leveraged and inverse ETFs already exist, and there are ETFs that target a specific commodity, such as crude oil or gold, single-stock ETFs are a new breed of fund. Here’s what investors should know about important distinctions and risks associated with these new products.
Single-stock ETFs use leverage to magnify or trade at the inverse the daily performance of the single stock they track. The risks and benefits of these ETFs are similar to other existing leverage or inverse ETFs in delivering desired returns over a specific period only, which is typically one day.
That desired return is the stated multiple, which is anywhere from minus two times to positive two times the return in the case of the single-stock ETFs. If held for more than one day, the returns can vary significantly from the exposure because these ETFs reset the leverage daily. For more detail on how leverage works, see ETF.com’s explainer on Leveraged & Inverse ETFs: Why 2x Isn't The 2x You Think.
The Securities and Exchange Commission approved these ETFs, but several commissioners warned that these are risky and potentially volatile investments.
Greg Bassuk, CEO of AXS Investments, told ETF.com on an Exchange Traded Fridays podcast that “these strategies are designed specifically for active traders, who are focused on making very short-term trading decisions and for those investors who already are doing that.”
These ETFs allow investors who have a strong directional view on a certain stock and want to make a tactical trading decision based on company news such as earnings announcements or regulatory developments, he said.
“These kinds of investors are more sophisticated in their investing, managing their portfolios and their investments literally on a daily basis,” he said.
These funds are not designed to be buy-and-hold ETFs as the desired returns are for only one day and investors holding these ETFs for longer periods may see a significantly different performance because of the impact of compounding. Investors may lose money, even if the underlying stock traded as expected.
Other Single-Stock ETFs Risks
There are several other risks associated with these ETFs. Unlike most products that include a basket of holdings, these funds target a single stock, which heightens concentration risk. Additionally, the fund uses swap agreements to get exposure to the stock. Many swap agreements trade over-the-counter in private transactions with a single financial institution. They are not subject to the Commodity Futures Trading Commission’s rules, the securities regulator that oversees exchange-traded swaps.
And since these ETFs focus on a single company, there’s a risk that a securities exchange may halt trading in the company if the exchange deems trading in the company’s stock is inadvisable. These trading halts can also affect the swap arrangements, which in turn will affect the ETF.
Inverse ETFs sell stocks short, and the unique risk of a short-selling strategy opens up the ETF to greater volatility and a decrease in liquidity in the financial instruments used to initiate the short position. Reduced liquidity could make it difficult for authorized participants to create additional ETF shares, known as creation units, a basic feature of ETF trading.