The recent selloff in AI-related stocks, particularly semiconductors, has highlighted how investors are using leveraged exchange-traded funds (ETFs) to amplify their bets, contributing to market volatility. These products, which use derivatives to provide two or three times the daily returns of an underlying asset, have seen a significant boom, now holding over $290 billion in assets globally. The U.S. market accounts for more than $220 billion, while Asia's market exceeds $45 billion, with South Korea being a notable epicenter for their use in AI-related investments.
The rapid growth of leveraged ETFs means they are increasingly influencing market movements. For example, Barclays estimates that rebalancing activities by U.S. leveraged ETFs have recently surged to an average of $20 billion per day over the past 10 sessions, significantly higher than the one-year average. This mechanical buying and selling, executed by fund managers to maintain promised leverage, can intensify rallies and exacerbate downturns, creating a "tail wagging the dog" scenario, according to Alexander Altmann at Barclays Equities Tactical Strategies.
The situation in South Korea underscores these risks. Following a 10% tumble in the Kospi Index, a global selloff in semiconductor shares ensued. While leveraged ETFs aren't solely to blame for triggering the retreat, strategists increasingly view them as a component of the speculative machinery that magnifies market swings. Products tracking chipmakers in Korea, launched in May with $3 billion in combined assets, have since ballooned to over $9 billion, indicating strong retail investor interest in high-octane AI plays. This amplification of both gains and losses has led to increased scrutiny from regulators, with South Korea's top markets regulator expressing regret over permitting single-stock leveraged ETFs. Critics warn that many retail investors may overlook the inherent risks, potentially leading to substantial losses when market momentum shifts.
