Leveraged & Inverse ETF ‘Mirage’

Lately, I've been getting a lot of reader emails about leveraged and inverse ETPs. A lot. I lost count at 60. (Maybe this is a good time to remind everyone that no, you really shouldn't buy and hold leveraged/inverse products. )

However, this morning I received a reader question that, to my surprise, wasn'tabout when the VelocityShares 3x Long Crude Oil ETN (UWT) will reopen (it won't), or how you can tell which ETNs will delist in advance (you can't).

Instead, this reader wanted to know how the current assets under management (AUM) in leveraged and inverse ETFs stacked up to historical norms.

Curious, I did some digging into our monthly ETF flows archive, and I thought the answer was so interesting it was worth sharing with the rest of the class.

Historical AUM For Leveraged & Inverse ETFs
Over the past 10 years, assets in leveraged ETFs and ETNs have risen from a low of $12 billion in 2010 to a peak of $40 billion in 2019.

Meanwhile, assets in inverse products have declined slightly over the same period, with bigger dips in 2018 and 2019. AUM dropped from a high of $21.4 billion in 2011 to $11.5 billion at the end of 2019.

So far in 2020, however, we've seen that trend reverse, with inverse products seeing their AUMs spike, while leveraged product AUMs have tanked:

Source: ETF.com. Data as of April 6, 2020. Author Note: Figures for 2012 and 2013 are from Jan-Nov., not Jan-Dec.

Shrinking Piece Of The Pie
Yet raw AUM data only tells one side of the story. We also need to put those numbers in context.

For example, let's look at investment assets in leveraged and inverse funds as a proportion of the total assets invested in ETFs overall:

Source: ETF.com. Data as of April 6, 2020.

Leveraged products have never commanded a significant portion of total assets invested in ETFs. But 10 years ago, they represented almost double the proportion of the pie that they do today, with 1.28% of total ETF assets invested in leveraged products in 2010, compared with just 0.68% in 2020.

Even as AUM for leveraged ETPs rose over the past decade, the percentage of the total ETF market that these products represented has actually declined.

The difference is even more stark for inverse products, which dropped from representing 2.13% of total ETF assets invested in 2020 to just 0.51% today.

One possible reason for the shrinking proportions: Institutional hedgers and active ETF traders—who are the main users for these products—have become a smaller portion of the ETF market, ceding market share to retail investors.

This means that leveraged and inverse ETFs are niche products, and they're only getting niche-ier.

Higher AUM Doesn't = Higher Flows
Net investment flows over the past several years into leveraged and inverse products also provide critical context to AUM numbers:

Source: ETF.com. Data as of April 6, 2020.

Over the past several years that data was available, investment in both leveraged and inverse exchange-traded products has been modest, with total flows into both products not breaking $10 billion total for most years.

But the one thing that pops out in the above chart is that, in 2019, we saw a significant drop in net inflows into leveraged ETPs—right when they were hitting their peak AUM of $40 billion.

AUM Mirage
When taken together, the data shows that the strong AUM growth we've seen into leveraged products, specifically, over the past few years has been something of a mirage.

It's not that these products are seeing a groundswell of investor interest per se, but rather that their assets have carried higher with the underlying markets they track. Most leveraged ETPs are tied to U.S. equity markets, which have spent the last decade in a bull market—so of course the leveraged ETPs based on those equity indexes would see a subsequent rise.

The same explanation holds for the fairly anemic market share of, and flows into, inverse products: Over the 10-year-long bull market, investors simply found fewer opportunities to short U.S. equities than to go leveraged long.

Today’s Market For These Products
That said, investment flows into leveraged products are back on the rise, and in a big way. In just the first three months of 2020, we've seen $6.9 billion enter these products —or more than the total invested in all 12 months of four of the past six years.

We're seeing investment flows rise into inverse products as well, including a massive $3.2 billion influx of cash last week; that category led new net flows across all asset classes (read: "Weekly Flows Steady As Markets Hold").

Of course, there's no way to tell right now who is buying these products. But if my inbox is any indication, I'm willing to bet that much of that new money is coming from retail investors who are flooding into leveraged and inverse energy ETFs and ETNs—just in time for them to close (read: "Leveraged ETF Closures Piling Up").

I'll be keeping my eyes on these numbers in the weeks ahead. Thanks for the reader questions, everyone. And please, keep them coming.

Contact Lara Crigger at [email protected]