(Bloomberg) — The late Jack Bogle — the father of the first index fund — loathed their exchange-traded offspring, warning that it only stimulates speculative trading among “fruit trees and nuts and nuts and nuts.” crazy edge. Fast forward to 2024, and critics warn that a new generation of ETFs are designed to do just that.
Enter the high-octane arena of single-stock funds, which use derivatives to amplify returns on an individual company.
Naysayers argue that funds encourage day trading at the risk of severe underperformance if held for more than just a few days. It took less than three days for the $4.8 billion GraniteShares 2x Long NVDA Daily ETF (ticker NVDL) — the largest single-stock fund — to see all of its holdings change hands, Bloomberg Intelligence data show.
Advocates say these ETFs are filling a demand in the investment world among a community of highly engaged retail traders. US-listed funds now command about $13.4 billion behind the former set sail two years ago, according to Bloomberg Intelligence data.
The debate highlights a cultural shift unfolding in the nearly $10 trillion U.S. ETF arena. The structure was born in 1993 as a passive, index-tracking vehicle—a reputation that continues today, even as record amounts of money pour into actively managed ETFs. However, the reality is that the industry is churning out more and more products aimed at satisfying the more speculative fancies of retail and institutional traders.
“For people stuck in the 1990s and 2000s, when ETFs were about tracking an index fund, these things trip them up, but it's an evolution of technology,” said Eric Balchunas, senior ETF analyst at Bloomberg Intelligence and author of The Bogle effect. “Bogle didn't like ETFs tempting you to trade, and he didn't like mutations and marketing. A leveraged, single-stock ETF has both the same.
The funds provide increased exposure only to a stock's one-day return, given that daily rebalancing of the options book erodes returns over time. Final example of GraniteShares 3x Long MicroStrategy Daily ETP (LMI3) listed in Europe of $11 million. While MicroStrategy itself is up more than 100% this year, LMI3 is down nearly 82% — despite offering long leveraged exposure to the stock. This dynamic also holds on a one-, three- and six-month basis.
Napkin math suggests that traders are following the guidelines. For example, the $1.5 billion Direxion Daily TSLA Bull 2X Shares ( TSLL ) fund has an average trading volume of nearly $303 million. Dividing that amount by the fund's average market capitalization of about $1.1 billion produces a turnover rate of 28.2%, which means it takes about 3.5 days to fully turn over its portfolio. That compares with about 185 days for the $503 billion Vanguard S&P 500 ETF ( VOO ), which is popular among buy-and-hold investors.
Such metrics can be seen as a very rough approximation of a fund's average holding period, according to Bloomberg Intelligence. While the frenzied turnover rate could be seen as good news because it means ETFs are being used as intended, it's likely that a group of less sophisticated traders are fuming, said Ben Johnson of Morningstar Inc.
“Inevitably, there will be unsuspecting victims of these products, for whatever reason — there are no adequate guardrails to prevent them from using them without adequate knowledge of how they should,” said Johnson, head of firm for customer solutions.
'worst nightmare'
Single-stock ETFs were launched in polemic in July 2022. While industry rule changes in 2019 and 2020 paved the way for listing such products, regulators quickly scoffed at them. SEC Chairman Gary Gensler said ETFs “present particular risk” just days before the first trades begin. Commissioner Caroline Crenshaw went a step further, warning investment advisers about recommending these products to retail traders.
The concern about single-stock ETFs was rebooted earlier this month with the launch of the Defiance Daily Target 1.75X Long MSTR ETF (MSTX), which seeks to provide leveraged daily returns on MicroStrategy Inc. Given that the stock itself already boasts a 90-day volatility of around 97%, the new offering is likely to rank as the most volatile US-listed fund on the market.
“MSTX is probably even worse than Jack Bogle's worst nightmare,” Johnson said. “Bogle couldn't understand that.”
For GraniteShares chief executive Will Rhind, such criticism amounts to little more than patronizing pearl-clutching. Rhind, who launched European single-stock ETFs in 2019 before going stateside, says the rise of the self-directed trader is a “super-macro investment trend”.
“We're trying to create products for that community, and that's a very different community than what a lot of the traditional asset management industry focuses on,” Rhind said.
While cheaper than other means of accessing similar degrees of leverage, single-stock ETFs are significantly more expensive than the recent fees that have come to define the industry.
For example, NVDL charges 1.15% annually, compared to the average expense ratio of about 0.7% for actively managed US-registered equity ETFs. Since these ETFs are held anywhere from a few hours to two days, most investors in the fund likely won't pay the entire 1.15% fee, Bloomberg Intelligence's Balchunas said.
While there is concern that such funds push individuals to trade at the expense of investing, the optimistic view is that they scratch the itch before it spreads, he said.
“There's an argument to be made that these single-stock ETFs are a byproduct of the core of the portfolio getting a little boring and people are looking for a little action,” Balchunas said. “If it keeps their hands off the core, it can serve a purpose, in a way of behaving.”