Single-Stock ETFs Look Shaky Despite Growing Popularity
- The risk of a total wipeout of a single-stock ETF is gaining, Bloomberg Intelligence says.
- Issuers are seeking out more volatile stocks to issue as leveraged funds.
- Around 160 single-stock funds have launched since the first in 2022.
ETFs that trade in a single equity, revved up with derivatives to multiply performance, have surged in popularity and pulled in billions of dollars, even as they are known as the riskiest, most volatile corner of the exchange-traded fund market.
As issuers seek out more volatile stocks to wrap into the leveraged ETF format, those risks appear to be growing, according to a new Bloomberg Intelligence analysis that highlighted what it sees as the possibility of a total wipeout of a fund in a single day.
“We believe there's potential for one of these products to lose their complete value in a single day,” Bloomberg Intelligence analyst Athanasios Psarofagis wrote in the recent report titled “ETF Issuers Might Be Pushing the Volatility Barrier Too Far.”
Single-Stock ETFs Surge in Popularity
In mid-2022, AXS Investments issued the first single-stock leveraged ETFs, which debuted eight ETFs that allow investors to use leverage or make inverse bets on Tesla Inc. (TSLA), Nvidia Corp. (NVDA), PayPal Holdings Inc. (PYPL), and others. This type of fund had already existed in Europe for a decade.
There are now 160 leveraged, single-stock ETFs that aim to double or triple the gain or decline in 80 different company stocks, according to Bloomberg. They are consistently the most actively traded funds: daily volume in the $5.2 billion Direxion Daily TSLA Bull 2X Shares (TSLL) exceeded 1 billion shares at least three times this year, according to FactSet data.
In Tuesday trading, the $167.6 million T-Rex 2X Inverse MSTR Daily Target ETF (MSTZ) had volume of more than 30 million shares before noon.
ETF Trading Volume as of 12:20 p.m. EDT on May 13—Source: FactSet
Riskier stocks are being targeted in an effort to boost returns, Psarofagis wrote. The average volatility for upcoming ETFs—those currently in the filings stage—is nearly double that of exchange-traded funds on the market, he said. The market cap of targeted stocks is also shrinking to around $14 billion from $156 billion, suggesting more volatility ahead.
“As issuers push into more volatile stocks, it increases the likelihood of a leveraged single-stock ETF seeing a complete wipeout in one day,” Psarofagis wrote, adding that the risks are greater among funds that bet on declining stock prices.
Leverage is also used to double or triple the return of indexes and sectors, such as in the popular Direxion Daily Semiconductor Bull 3X (SOXL).
Quantum computing stocks are the most volatile and at risk when issued as ETFs, the note said. Bloomberg analyst Eric Balchunas wrote in an X post Monday that the Tradr 2X Long QBTS Daily ETF Trader 2X Long QBTS Daily ETF (QBTX) is the most volatile ETF, labeling it “the new Ghost Pepper ETF” with a volatility reading of 427%. That fund aims to double the return of D-Wave Quantum Inc. (QBTS).
Investors Comfortable with Added Risk
Still, investors appear to understand the risks involved, according to the note.
"We believe they're willing to overlook and even understand the risks associated with such products," Psarofagis wrote. "Even a blow-up incident appears unlikely to dissuade investors from using ETFs."
