Why Some Regulators Have ‘Regrets’ Over Leveraged Single-Stock ETFs

They say hindsight is 20/20.

South Korea’s top financial regulator said last week that he has “regrets” about allowing leveraged single-stock funds to trade in the country, warning that the products can add significant volatility into the market. The official, Financial Supervisory Service Governor Lee Chan-jin, also cited his concerns regarding leveraged funds that track high-flying AI stocks, particularly for non-professionals, according to a Bloomberg report. Chip-makers have seen huge gains, per the report, which has only added volatility to the products. The Securities and Exchange Commission also halted its review of ETFs that provide anything over 2x exposure to their underlying holdings last year. Lee’s statements were no surprise given the actions of US regulators, said Joy Yang, global head of index product management at MarketVector Indexes.

“Regulators have to balance investor protection and market integrity, but they also want to promote financial innovation,” she said, adding that leveraged products have allowed retail investors to access previously unavailable strategies. “I think it’s very clear that these products, especially in the ETF wrapper, have created a lot of innovation.”

X Marks the Spot

There certainly has been plenty of demand from investors, not just across diversified baskets of leveraged products but also in the single-stock category. The products also got a significant boost following the highly anticipated SpaceX IPO, with leveraged funds following the space tech behemoth raking in $1 billion in a single day. “These are high-risk products, and it seems like about 92% of holders are retail investors,” Lee stated in the press conference. Still, there’s more to consider than just domestic affairs, since outlawing leveraged products at home could simply drive more investors overseas, Yang said.

“What we saw with capping leveraged ETFs at 2x [level], the demand just moved elsewhere, offshore to other jurisdictions that allow 3x, 5x or even, what we see in the digital asset world, 20x, 50x,” Yang said. “I think it would benefit regulators to keep investors where they can see them.”

Buy and Do Not Hold: Beyond regulatory action, Yang said investors need to be educated on how single-stock products work and how they can fit into a portfolio. Regulators should offer more either guidance and investor protection regarding the packaging of and education surrounding these funds, she said. “There’s a huge gap between the theoretical price of what the return opportunity is for something that goes up, and [its price] in volatile markets or with volatile underlying assets,” Yang said. “That clearly needs to be raised to the forefront. These are not buy-and-hold products.”