What Are Single-Stock ETFs? New Funds Add Leverage, Risk

The U.S. launch of a new type of exchange-traded fund, or ETF, is giving investors a different way to make leveraged bets on some of the most popular stocks in the market, but regulators are warning investors to understand the risks associated with single-stock leveraged ETFs.

AXS Investments introduced in July a suite of eight single-stock leveraged and inverse ETFs that allow investors to make more aggressive bets on the success or failure of a handful of polarizing stocks.

These leveraged single-stock ETFs are designed to appeal to short-term traders, such as traders looking for ways to make a leveraged bet on a quarterly earnings beat or miss. The U.S. Securities and Exchange Commission has said single-stock ETFs are complex products with the potential for elevated risk and volatility.

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What Is a Single-Stock Leveraged ETF?

ETFs typically provide investors with a way to gain diversified exposure to a large number of different types of stocks or other assets all at once via a single fund. For example, by buying the SPDR S&P 500 ETF Trust (ticker: SPY), investors can invest in all companies in the S&P 500 index.

Instead of investing in a basket of stocks, single-stock leveraged ETFs hold derivatives designed to generate a particular multiple of the return of a single underlying stock on any given trading day. If a stock rises 4% following an earnings beat, a single-stock ETF with 2x leverage is designed to gain 8% that day. A single-stock inverse ETF is designed to generate a 4% loss in that case.

AXS has launched the following eight single-stock ETFs:

— AXS TSLA Bear Daily ETF (TSLQ), a Tesla Inc. (TSLA) inverse ETF.

— AXS 1.25X NVDA Bear Daily ETF (NVDS), a Nvidia Corp. (NVDA) 1.25X leveraged inverse ETF.

— AXS 1.5X PYPL Bull Daily ETF (PYPT), a PayPal Holdings Inc. (PYPL) 1.5X leveraged ETF.

— AXS 1.5X PYPL Bear Daily ETF (PYPS), a PayPal 1.5X leveraged inverse ETF.

— AXS 2X NKE Bull Daily ETF (NKEL), a Nike Inc. (NKE) 2X leveraged ETF.

— AXS 2X NKE Bear Daily ETF (NKEQ), a Nike 2X leveraged inverse ETF.

— AXS 2X PFE Bull Daily ETF (PFEL), a Pfizer Inc. (PFE) 2X leveraged ETF.

— AXS 2X PFE Bear Daily ETF (PFES), a Pfizer 2X leveraged inverse ETF.

“With the launch of this highly innovative family of ETFs, AXS has once again opened new access for investors, namely to express their high-conviction views on some of the most actively traded single stocks, regardless of whether their sentiment is bullish or bearish,” AXS Investments CEO Greg Bassuk said in a news release.

Leveraged and single-stock ETFs are not new ideas. Leveraged ETFs such as the ProShares UltraPro QQQ (TQQQ) and the ProShares Ultra Bloomberg Crude Oil (UCO) provide investors with leveraged exposure to commodities and diversified baskets of stocks. In addition, single-stock ETFs similar to the new batch of AXS funds are already on the market in Europe.

[READ: An Investor’s Guide to Options Trading.]

Pros and Cons of Single-Stock Leveraged ETFs

Leveraged single-stock ETFs can give investors an opportunity to generate larger returns on a trade with a smaller up-front investment than a similar trade involving the underlying stock. Nike or Pfizer traders can essentially double their returns by betting on the AXS leveraged ETFs rather than Nike or Pfizer shares themselves.

In addition, these inverse and leveraged single-stock ETFs may carry less risk than short selling the underlying stock or placing leveraged trades using call and put options. Many options contracts expire out of the money and become completely worthless, and short selling positions come with borrow fees and can generate losses way above the size of the initial position.

However, because these single-stock ETFs rebalance on a daily basis and their derivative holdings suffer from time value decay, SEC Commissioner Caroline Crenshaw says, compounding rebalancing effects can cause these ETFs to diverge significantly from the performance of their underlying stocks over time.

“In other words, investors’ returns over a longer period of time might be significantly lower than they would expect based on the performance of the underlying stock. These effects are likely to be especially pronounced in volatile markets,” Crenshaw says.

[Read: Guide to Low-Cost Index Funds.]

Unlike the underlying stocks, these funds also charge management fees that can eat into investor profits. The AXS single-stock ETFs have expense ratios of 1.15%, some of the highest ETF management fees in the market.

Finally, because these ETFs track the price of just a single stock rather than an index, they miss one of the primary benefits of traditional ETFs: diversification. In fact, Lori Schock, director of the SEC’s Office of Investor Education and Advocacy, says single-stock ETFs provide the exact opposite of diversification.

“Because levered single-stock ETFs in particular amplify the effect of price movements of the underlying individual stocks, investors holding these funds will experience even greater volatility and risk than investors who hold the underlying stock itself,” Schock says.

More Single-Stock ETFs Are Coming

So far, AXS is the only firm that has launched its single-stock ETFs in the U.S., but Direxion, GraniteShares and Kurv Investment Management have all filed for their own set of single-stock funds, as well.

In all, these proposed single-stock ETFs represent 35 publicly traded companies ranging from blue chip stocks like Boeing Co. (BA) and Ford Motor Co. (F) to social media stocks like Twitter Inc. (TWTR) and Meta Platforms Inc. (META) to energy giants like ConocoPhillips (COP) and Exxon Mobil Corp. (XOM). GraniteShares is even planning to launch single-stock ETFs tied to some particularly volatile stocks, including Tilray Brands Inc. (TLRY), Peloton Interactive Inc. (PTON) and Coinbase Global Inc. (COIN).

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What Are Single-Stock ETFs? New Funds Add Leverage, Risk originally appeared on usnews.com

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