Short and leveraged (S&L) specialist Leverage Shares has acknowledged investors did not receive the full advertised three-times amplified returns on its Tesla leveraged exchange-traded product (ETP) for six days last month.
Europe’s largest S&L ETP – the $315m +3x Tesla ETP (TSL3) – experienced “significant tracking error” due to “technical issues with the margin loan provider”, the firm said.
This saw the degree of leverage applied to the underlying exposure drop to 2.8x during sessions where Tesla stock rallied 6.6% in total.
One explanation for the shortfall in returns is Leverage Shares was unable to access the necessary financing to provide the full three-times amplified exposure, an argument a company spokesperson said was “legally accurate”.
The firm’s leveraged ETPs differ from those of rival providers by being physically backed, meaning the asset manager needs to borrow funds to purchase additional shares to provide its leveraged exposure.
This may have posed an unexpected challenge to Leverage Shares given the size of TSL3 versus its other strategies.
The firm said the incident was the first time such tracking error was experienced in its five years of operating ETPs.
Raj Sheth, commercial director at Leverage Shares, told ETF Stream: “We made a mistake. We are now at $600m assets, four-times last July.
“Everyone was laughing at Elon Musk when he was trying to scale up Tesla quickly. He had issues and he admitted it. We are doing the same.”
Previously, the firm operated with a single prime broker, Interactive Brokers Ireland. It recently onboarded Goldman Sachs as a second prime broker where it holds “significant balances” supporting TSL3, a key step to “minimise similar risks and build for expected future growth”, the issuer said in a statement.
“We have overcome the issues we have faced,” Sheth continued. “We are now signed with Goldman Sachs. If the product continues to grow, we can scale it up.”
He added the firm is not trying to compete with vanilla ETFs but its ETPs are safer than CFDs. If the company were to ever fail, the physically backed structure means investors would still be able to access the underlying assets, Sheth concluded.
Some have viewed Leverage Shares’ error as just the latest fable on the risks of short and leveraged products, with Credit Suisse’s short volatility VIX WTP and WisdomTree’s three-times leveraged oil ETP closing after single days of market volatility.
Despite seeming structural question marks, other onlookers such as Athanasios Psarofagis, ETF analyst at Bloomberg Intelligence, are less concerned.
“So, the leverage dropped to 2.8x from 3x? That does not seem like a big deal to me, especially given how volatile Tesla stock can be,” he said.
“Even with that, leverage offers very unique exposure and the product class tends to endure on, even with any type of black eye such as what has happened with exchange-traded notes (ETNs) previously.”