Consider the attributes of the exchange-traded fund: low fees, fewer tax liabilities than a mutual fund, the ability to hold a broadly diversified portfolio in one security, lower risk and trading flexibility.
In other words, the ETF is the financial embodiment of the KISS theory: “Keep It Simple, Stupid.”
Until 2022.
ETFs with single stock
Since midsummer, a number of ETFs built around owning a single stock have emerged. Many are structured as leveraged funds, which means they use a variety of investment strategies, including swaps, futures and other derivatives, to magnify bets on the direction of an individual stock. Others are inverse funds, intended to move in the opposite direction of the day’s trading, profiting when the stock falls and falling when the stock gains. They add a layer of complexity and risk that seems at odds with the very idea of ETFs.
The first of these funds debuted in July: eight from AXS Investments holding positions in Tesla, PayPal, Nvidia, Nike and Pfizer with leveraged long or short positions of one to two times the stock’s daily movement. Since then, at least 35 more ETFs have been announced in filings from Direxion, GraniteShares and Kurv Investment Management targeting Boeing, Disney, Goldman Sachs, Netflix, Uber and others.
The AXS TSLA Bear Daily ETF had gained 3.31% by Tuesday, while Tesla shares had fallen 38.54%.
Stock traders already use options and derivatives to make leveraged bets on the direction of a single stock. The benefit of wrapping those strategies in an ETF is that the fund can simplify the process at a lower cost while avoiding short-term capital gains taxes.
It’s that simplicity that worries investment experts.
Hold only for a day
“Leverage sounds great on the upside, but investors forget that it cuts both ways,” said Wes Crill, head of investment strategists at the investment adviser Dimensional Fund Advisors.
These new single-stock ETFs aren’t intended to be held for more than a day, because the leverage or inverse ratio must be rebalanced after every day’s market activity. While an investor might be smart to buy and hold shares of a single stock, that approach could be disastrous for someone invested in one of the new ETFs as the daily reset of the funds compounds the fund’s exposure to a dangerous level.
That’s why these funds are aimed at trading, not investing. The disclosures on the AXS funds make that clear: “The funds are not intended to be used by, and are not appropriate for, investors who do not intend to actively monitor and manage their portfolios.” The chief executive of AXS Investments, Greg Bassuk, did not respond to requests for comment.
Risks for individual investors
Still, some investment professionals have expressed concern about the risk that some single-stock ETFs pose to individual investors, starting with Caroline Crenshaw, a commissioner of the Securities and Exchange Commission. “I worry that these single-stock ETFs pose yet another, perhaps greater, risk for investors and the markets,” Crenshaw said.
Concern about the riskiness of the new ETFs ratcheted up after three fund managers filed plans in August to offer single-stock ETFs of foreign stocks that don’t trade on U.S. exchanges and aren’t subject to U.S. accounting and financial disclosure rules. The managers, Kelly Intelligence, Roundhill Investments and Tema Global, sought to create 130 funds of firms including Saudi Aramco, Samsung and Volkswagen. But all were withdrawn by the end of September. Analysts suggested that the SEC might have privately indicated that it wouldn’t approve the funds.
“This is pretty telling that the ETF industry has come full circle,” said Sean Allocca, editor-in-chief of ETF.com. “The irony is that when ETFs came out, the benefit was that you could track these large indexes and it was pretty cheap.”
The most popular of the AXS funds is AXS TSLA Bear Daily ETF (TSLQ), an inverse fund that bets against shares of Tesla. The fund started trading in mid-July at $51.63 and has ranged from $36.25 to $46.09, attracting $59.4 million in assets with a net expense ratio of 1.15%. Three other AXS funds list assets of $800,000 or less. By comparison, the iShares Expanded Tech Sector ETF, with broad exposure to the technology sector, has assets of $2.8 billion with a net expense ratio of 0.40%.
Doing it with Treasurys
One new family of single-entity ETFs that could hold wider appeal comes from the boutique advisory firm F/m Investments and is intended to track the current rates on the 10-year U.S. Treasury bond, the two-year Treasury bond and the three-month Treasury bill.
“Bond trading is messy no matter how well you try to do it, and we do it every day,” said Alexander Morris, president and chief investment officer of F/m. “You could do all of this today with options and derivatives, but you need to have pros who do this every day. We used the beauty of the ETF and just did the simplest thing possible.”
Issued in August, the three Treasury funds have attracted $164 million in assets with an expense ratio of 0.15%. F/m plans to issue seven more funds for Treasurys with durations of six months to 30 years.
F/m’s two-year Treasury ETF closed at $49.11 on Tuesday, and has ranged between $49.07 and $49.99 since it debuted Aug. 9. The latest rate on the two-year bond is 4.25%.
Most do-it-yourselfers tend to be best served with diversified portfolios of low-expense funds built around their own needs, timeline and risk tolerance.
“What investors need more than ever are robust cost-effective solutions, and, to us, that means broad diversification,” said Crill of Dimensional Fund Advisors. “Single-stock ETFs take that concept and throw it out the window.”
c.2022 The New York Times Company. This article originally appeared in The New York Times.
