SEC Warns Investors About Single-Stock ETFs

July 12, 2022

Leveraged and inverse single-stock ETFs will be available in the U.S. in the coming weeks, but investors should be wary, according to statements from two Securities and Exchange Commission officials. 

AXS Investments has the green light to debut any of more than a dozen leveraged or inverse exchange-traded funds tied to individual stocks, according to a filing with the SEC. The ETFs target stocks including Tesla, ConocoPhillips, Boeing, PayPal, Wells Fargo, Salesforce, Nike and Nvidia.  

 

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However, SEC Commissioner Caroline Crenshaw warned about the risks of such products in a statement Monday. 

“As with other complex exchange-traded products, single-stock ETFs may be useful to certain investors who understand their unique features,” she said. “However, they are risky products for investors and potentially for the markets, as well.” 

The AXS TSLA Bull Daily ETF (TSLU), which would track shares of the volatile, electric vehicle maker Tesla, offers holders returns equal to 1.1 times the daily performance of Tesla stock, while the AXS 2X COP Bear Daily ETF (COPQ) gives holders 2 times daily inverse exposure to ConocoPhillips stock.  

AXS will likely be the first of several issuers to offer these types of funds to U.S. investors. GraniteShares, Direxion, along with a few smaller fund companies, are also looking to bring single-stock ETFs to market. 

Already In Europe  

Though single-stock ETFs are novel in the U.S., in Europe, they’ve existed for a while—and the exposure they offer is more potent than the funds that AXS Investments is looking to launch. 

For instance, the GraniteShares 3x Long Tesla Daily ETP and the GraniteShares 3x Short Tesla Daily ETP are much more volatile products than the aforementioned TSLU. 

They are also much more dangerous products as well, no thanks to the unforgiving math behind daily rebalancing. For instance, the 3 times long Tesla ETP is up 75% since July 2020, much less than the 215% gain for Tesla shares themselves. Of course, the 3 times short Tesla ETP has done much worse, losing 99.99% of its value in that timespan.  

 

 

Today in the U.S., the most common leverage factors are two and three times, but up until now, those ETFs have provided leveraged exposure to indexes, other ETFs or individual commodities. 

The single-stock leveraged ETF is a new product category that will surely be attractive to aggressive traders—particularly retail traders—hoping to hit a home run in the markets.  

SEC Commissioner Calls Out Risks 

With few exceptions, when it comes to leveraged and inverse ETFs, the potential for huge gains in the short term comes with the likelihood of huge losses in the long term. 

Certain leveraged and inverse ETFs can escape that eventuality, but they are usually tied to diversified indexes in long bull markets or super-safe assets like Treasuries. 

Single-stock ETFs offer neither, and thus are almost assured to be money losers long term. 

Crenshaw noted that were it not for Rule 6c-11, which the SEC adopted in 2019, these ETFs wouldn’t have been able to come to market.  

“In combination with changes to the listing standards at stock exchanges, that rule created a framework that allowed exchange-traded funds (ETFs) meeting certain criteria to come directly to market without first obtaining permission, through what is called an exemptive order, from the SEC.” 

“Nowhere in Rule 6c-11 is there a discussion of single-stock ETFs; there is no indication that the rule contemplated such products. However, single-stock ETFs are nonetheless coming to market under the auspices of that rule.” 

Crenshaw urged the SEC to update its regulatory framework and use the tools it already has to decide whether products like these are appropriate for investors. 

“I am disappointed that, months after Commissioner Lee and I called for improvements to the rules for complex exchange-traded products, we have not updated our regulatory framework to better address the risks these products pose to investors and the markets.” 

“Further, with respect to single-stock ETFs in particular, I am disappointed that the Commission has thus far failed to make use of the tools it does have, such as rulemaking under the Investment Company Act of 1940 and/or the Securities Exchange Act of 1934, to grapple with the question of whether these products are appropriate in the public interest and consistent with the protection of investors. I strongly encourage my colleagues to consider rulemaking in this case.” 

In a separate statement, the SEC’s Director of the Office of Investor Education and Advocacy Lori Schock also pointed out the risks inherent in leveraged and inverse single-stock ETFs.  

 

Follow Sumit on Twitter @sumitroy2  

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