Matt Tuttle, CEO and CIO of Tuttle Capital Management, who has been launching ETFs for ten years and now manages about $4 billion in assets, suggests that leveraged ETFs can actually be a safer alternative to margin accounts for investors seeking amplified returns on a stock. He highlights that for an everyday investor wanting 2x leverage on a stock, an ETF offers a more controlled environment. This perspective comes amidst a broader discussion about the rapid growth of leveraged ETFs and their potential impact on market stability.
The debate surrounding leveraged ETFs, particularly single-stock varieties, is intensifying. While some experts like Mike Akins of ETF Action believe the market is getting "a little carried away" with leverage, they acknowledge that these products generally do what they intend. However, Akins and others raise concerns about the overall market ecosystem, suggesting there might be a "breaking point" for certain leveraged products. This indicates a tension between the demand for leveraged products and the potential systemic risks they introduce.
A significant concern highlighted by financial analysts is the daily rebalancing mechanism of leveraged ETFs. For instance, a 3x leveraged ETF must adjust its exposure at the end of each trading day to maintain its target. This can lead to "leverage decay" for long-term holders in volatile markets. Moreover, the growth of these ETFs, with U.S. leveraged ETF assets reaching over $200 billion and Asia Pacific assets tripling to over $50 billion, is causing an increase in "short gamma." This means that leveraged ETFs amplify market moves, potentially exacerbating selloffs as they force mechanical selling during downturns. A 10% index drop could trigger over $10 billion in mechanical selling to maintain leverage targets.
Despite these risks, the demand for leveraged ETFs continues to grow, and more products are being launched. Alex Morris, CEO of F/M Investments, notes that while the futures and options markets offer higher leverage (10x to 100x), the reduced paperwork and disclosures associated with ETFs make them a more attractive wrapper for these types of trades. However, both Morris and Akins emphasize that investors must understand the inherent risks. Morris points out that a common mistake is investors wanting to "amplify a guaranteed win," and that unchecked growth could lead to a "something bad happening" scenario, prompting increased scrutiny from regulators like the SEC, who recently announced a request-for-comment period on novel investment strategies.
Ultimately, while Tuttle views leveraged ETFs as potentially safer than some options for specific investor needs, the broader sentiment among experts is a blend of caution and concern regarding the rapid expansion and potential systemic influence of these products. The market's inability to self-regulate against potential harm, coupled with the SEC's increased attention, marks a critical juncture for this segment of the ETF industry.
