Will Hourly Resets Seriously Spice Up Leveraged ETFs?

Who remembers the psychological thriller Memento from the year 2000?

Like the Christopher Nolan film’s central character, who has anterograde amnesia and thus cannot make long-term memories, a suite of proposed exchange-traded funds would reset hourly. Last month, Defiance ETFs filed with the Securities and Exchange Commission for 16 2x-leveraged funds that, unlike existing products in the category that reset daily, would have six “intraday execution periods,” focused on popular single stocks like SpaceX, Meta and Palantir, as well as the Roundhill Memory ETF (DRAM). While that could resonate with day traders who are quite serious about watching the clock, the strategy seems to be a different way of approaching the SEC’s 2x limit on leverage for new funds.

“They’re trying to get around concerns the SEC has expressed around higher leverage,” said Benjamin Schiffrin, director of securities policy for Better Markets. “It’s fair to say this is risky, if not riskier, than an ETF that is 5x leveraged but in a different wrapper.”

Cut It in Half and Double It

Leveraged single-stock ETFs are notorious, and sought out, for their volatility. Issuers are clear, at least in fund documents, that the products are intended to be traded intraday by experienced investors. That’s because the losses can add up and are difficult to recover from, a quality known as decay. If, for example, a stock loses 20% in a day, then fully recovers the next, investors who held a leveraged single-stock fund during that time frame will end up with less money than they started with. Adding reset periods throughout the day would make it that much more critical for traders to get in and out of the funds quickly.

“These ETFs are designed for short-term traders who actively manage their positions throughout the day,” said Roxanna Islam, head of sector and industry research at TMX VettaFi. “Because they reset multiple times throughout the trading day, they carry greater compounding risk than traditional daily-reset leveraged ETFs.” Or, as TradingBlock vice president of market strategy Michael Martin said, volatility requires bigger moves to break even.

“Intraday volatility runs hotter than close-to-close volatility in these [stock] names, and the filing says so,” he and Chief Innovation Officer Michael Rechenthin said in comments to ETF Upside. “You lose 50%, you have to make 100%. Six resets a day gives that math more chances to run.”

As trading tools, leveraged ETFs have helped some people achieve outsized returns, but many funds have lost money, which highlights the problem for buy-and-hold investors:

• The median fund return was -38% over four years, per a report from Morningstar.
• Meanwhile, the median trading volume was 22%, meaning that investors largely held positions longer than a day, the report found.

Short-Term Memory: Defiance did not respond to a request for comment about the proposed funds. But whether the SEC decides to hold up the funds is a big question: The regulator is currently collecting public comments about “novel” ETFs with strategies that resemble gambling, and some issuers appear hopeful that it will eventually overturn its 2x leverage limit. “The SEC probably will have concerns similar to the concerns they had with 5x leveraged single stock ETFs,” Schiffrin said. “It’s just not clear that retail investors are going to appreciate how quickly you can lose your money.”