Taiwan shows another way on leveraged ETFs

David Tuckwell

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Taiwan shows that retail investors don't have to hate leveraged ETFs

Leveraged and inverse ETFs have the reputation for being somewhere between a casino product and a Frankenstein's monster.

Back in 2014, BlackRock boss Larry Fink warned that leveraged ETFs could "blow up the whole industry one day" and swore that iShares would "never" issue one.

It was always thought that Mr Fink spoke for many.

SocGen has an entirely separate website for its leveraged and inverse products - keeping the distinction between the safe vanilla and risky leveraged sharp. When Trump's new SEC chair allowed 4x leveraged ETFs to go ahead, the decision was heavily criticised.

But the negative take on leveraged and inverse ETFs comes unstuck in Taiwan, where the instruments are wildly popular.

In Taiwan, leveraged and inverse ETFs are the most popular kind of ETFs. In fact, as of April 2017, they made up roughly 52% of Taiwan's ETF market, according to data from Morningstar. This despite regulators only giving leveraged ETFs the green light in 2014.

Taiwanese issuers understand the demand - and respond. Thus, when Taipai-based banking major Taishin made its entry into the ETF issuers' market this month, two of its three opening products were leveraged and inverse.

One obvious question to fall out of this is: why are leveraged ETFs so popular in Taiwan?

One answer might be that traders dominate the Taiwanese ETF market - leveraged products are, after all, designed mostly for traders, aren't they? And don't east Asian countries like South Korea have the biggest derivatives markets per capita?

Well, if you thought that you'd be wrong. According to a spokesperson for the Taiwan Stock Exchange, contacted by ETF Stream:

"In Taiwan, the retail investors count for 65% trading volume of the whole market, which is pretty different from the international markets. The retail investors prefer buying leveraged/inverse ETFs as well as medium-small companies' stocks."

So not only are leveraged ETFs more popular than plain vanilla ones in Taiwan, it's the retail investors who dunnit.

Maybe the better question is why are leveraged ETFs so stigmatised in the west?

Part of the reason, we're always told, is risks and how they're amplified. As everyone knows, while leveraged ETFs magnify upsides, they also magnify downsides.

Another reason concerns fees. Leveraged ETFs are more expensive. As one of the top selling point of ETFs is their low cost, leveraged ETFs undercut a major product advantage.

The final reason is their use of dread derivatives, which the 2008 financial crisis did so much to discredit. As Kate Stalter of Better Money Decisions writes:

"A handful of investment banks act as the counterparties to the several billions of dollars of derivative contracts held by the top six leveraged ETFs. The vast majority of these derivatives contracts are concentrated at Goldman Sachs, Bank of America, Credit Suisse, and Citibank."

Yet each of these reasons - cost, risk, and derivative use - holds equally in Taiwan. Yet the Taiwanese manage to see past it.

So who's the wiser? Taiwanese investors or western ones? Maybe it doesn't matter. But what it shows, if nothing else, is that opinions of leveraged ETFs can and do vary.


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