A trio of money managers want to sell exchange-traded funds that amp up swings in Tesla, Bitcoin and other assets to a rarely seen degree, setting the stage for another test of regulators’ tolerance for ultra-risky offerings.
Defiance ETFs, Themes and Direxion have filed for leveraged products designed to deliver three times the daily return of some of the market’s hottest trades. The approach is novel: 3x ETFs on single stocks don’t currently exist in the US, given volatility rules set by the Securities and Exchange Commission that cap how much leverage a fund can offer.
How the proposed vehicles intend to get around those directives wasn’t immediately clear. They are, however, a step up the risk ladder in a rapidly growing market where issuers are forced to push the envelope in order to stay competitive. ETF assets have ballooned to nearly $13 trillion, with some 4,400 funds vying for investor cash.
“This is a natural progression of the ETF market right now — they try to push as far as they can go, one-up each other,” said Bloomberg Intelligence’s Athanasios Psarofagis. Issuer objectives have evolved in recent years, he added. “Before, it was undercutting each other on fees. Now, it’s upping on things like income, yield or leverage.”
SEC Hopes
Leveraged ETFs have endured their share of criticism in recent years, with skeptics saying they tempt amateur investors with products that are both risky and opaque. Some triple-leveraged single-stock products, which are available in Europe, have recently demonstrated their propensity for rapid declines. For instance, the Leverage Shares 3x Tesla ETP is down 65% this year, even as shares of the EV-maker are up 11% during the same stretch.
Issuers counter that they are simply meeting client demand among a community of retail traders that is clamoring for high-octane strategies. The products’ popularity among investors is hard to deny, with nearly one-third of all ETFs launched this year having a leverage component, according to data compiled by Bloomberg Intelligence. While some funds offering 3x leverage already trade in the US, they focus on broad indexes and are a remnant from before current guidance was established five years ago.
The fate of the latest filings may largely depend on whether the issuers can sway the SEC, which capped new funds at a maximum of 2x leverage in a bid to protect investors from potentially catastrophic losses. If they pass muster, the new crop would introduce investors to a new paradigm of risk and reward.
Defiance’s various funds, for instance, would target three-times the daily returns of their underlying via various “financial instruments,” including potentially swaps and options, according to the filing, where Milliman Financial Risk Management is listed as a subadviser. The funds would achieve their 3X returns by rebalancing holdings daily. The issuer is also looking to offer triple short ETFs, which would offer inverse returns.
Sylvia Jablonski, CEO of Defiance, declined to comment. Representatives for Direxion and Themes didn’t immediately respond to requests for comment. Filings from all three firms hit the docket on Friday.
For now, many companies may be pinning their hopes on the SEC being more permissive under President Donald Trump’s administration. The regulator didn’t immediately respond to requests for comment, citing the ongoing US government shutdown. Industry players, however, have said the watchdog has already clarified its guidance on what securities can form the basis of a leveraged single-stock ETF.
At the same time, riskier or more complex types of funds also tend to let issuers charge higher fees, another motivation for companies to keep the presses rolling.
Todd Sohn, senior ETF analyst at Strategas Securities, expects products to continue growing more complicated as companies increasingly compete for market share and use derivatives to fulfill fund objectives.
This is “more and more evidence that the simplicity, vanilla era of ETFs is over, and we are well into the complexity era,” he said. “These are a reflection of how popular options-based strategies have become.”
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