Are single stock ETFs foolish?

The products are laden with risk, according to an industry expert

Allan Roth

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Do you think Nike is overvalued? Or maybe you think it is a bargain and that the price will surge.  

You could turn to derivatives such as options, or short-selling to cash in, though it would take time if you do not have the right account features. Now, you can put on those Nikes and run to take a position with two times leverage betting either for or against the stock.  

AXS Investments has launched its family of eight single stock ETFs. Matthew Tuttle, managing director at AXS Investments, told me the firm has $39.7m assets under management (AUM) across its range, as at 21 July.

Continuing to use Nike as an example, for a 1.15% annual expense ratio plus the bid/ask spread of a round-trip investment, you can earn twice the daily return of the stock, or the inverse return if you buy the bear version.  

I first wrote about levered and inverse levered ETFs over a decade ago, in which I noted that both the levered ProShares ultra-long and short triple levered S&P 500 fund lost substantially in the same year when the market was flat. ETF.com’s Sumit Roy explained the math of why this happens (daily rebalancing) in a recent podcast.

As these ETFs have been around in Europe for a few years, Roy compared the returns of the single stock Tesla levered products to the stock itself. Since July 2020, Tesla returned 212%, while the three times Tesla long product gained only 72%, and the inverse three times Tesla product lost 99.99% of its value.

Now, in fairness to AXS Investments, it explains up front on its website that these are “intended to be used as a short-term trading vehicle for traders and sophisticated investors who understand the risks and benefits of these type of funds.” Tuttle defined short-term as “one day”, though some may choose to hold longer.

My take

While I appreciate the warning that these are not to be used for the long term, I couldn’t disagree more that these are “for sophisticated investors who understand the risks and benefits”. I see huge risks, but no benefits.  

In fact, I do not even think these products have anything to do with investing, and have everything to do with speculation. I expressed the sentiment that investing is a long-term endeavour to Tuttle, which replied that, for some, it is about short-term trading, and these ETFs are a tool for those investors’ needs.  

In eight words, my definition of investing is “minimising expenses and emotions; maximising diversification and discipline”. These single stock ETFs are the exact opposite – they are levered, concentrated, expensive products that prey on your emotional conviction of being much smarter than the market in the short term. In fact, to win, you will likely have to cover the expenses and the math that is working against you.

I thought broad-levered ETFs such as the ProShares levered 500 long and inverse ETFs were the worst ETFs that Wall Street could launch; I was clearly wrong. A single stock ETF will have greater volatility, which translates to more rebalancing resulting in the math working against good performance. I agree with the SEC warning about these ETFs.  

The late Vanguard founder Jack Bogle was initially against ETFs, as he feared people would use them as trading vehicles rather than for long-term investing. He softened his view over time and agreed that ETFs can be used for long-term investing. Add in the tax benefits of ETFs in the US over mutual funds, and they can be a great vehicle for investors.

Yet single stock ETFs go much further than the stock picking Bogle warned against. Single stock ETFs may be brilliant for the issuer, but they are foolish for the investor. You might have better odds buying a winning lottery ticket.

Allan Roth is founder of Wealth Logic. He is required by law to note that his columns are not meant as specific investment advice.

This story was originally published on ETF.com

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