What is a single-stock ETF and why are advisors wary? | Business News | Investment
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These days, exchange-traded funds, or ETFs, can do much more than passively track a basket of stocks. For example, the recently introduced single-stock ETFs allow traders to place large bets on individual stocks.
The first single-stock ETFs hit US markets in July 2022, but since then several ETF issuers have launched new ones. Here’s a look at how they work, how popular they are, and what advisors have to say about them.
What are Single Stock ETFs?
Single-stock ETFs are leveraged ETFs whose performance is tied to the daily performance of an individual stock. They come in a few different varieties:
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- Long single stock ETFs with leverage target a multiple of their actions. For example, the AXS 2X NKE Bull Daily ETF (NKEL) targets twice the daily return of Nike stock. So if Nike goes up 2% on a given day, the ETF is supposed to go up 4%.
- Short Single Stock ETFs target the inverse of their stock. The Direxion Daily TSLA Bear 1X Shares ETF (TSLS), a short single-stock ETF, tracks the opposite of Tesla’s daily performance. This means that if Tesla stock falls 5% on any given day, the ETF should rise 5%.
- Leveraged Short Stock ETFs target a negative multiple of their stock. One example, the AXS 2X PFE Bear Daily (PFES) ETF, is designed to give twice the opposite of Pfizer’s daily return. So, if Pfizer drops 4% in one day, the ETF should rise 8%.
- Single Stock ETFs Hedged target a limited version of the daily gains and losses of their stocks. The Innovator Hedged TSLA Strategy ETF (TSLH), for example, attempts to provide Tesla’s daily return but is capped at a maximum of 9.29% and a minimum of -10%.
As with other leveraged ETFs, issuers of single-stock ETFs attempt to achieve their return objectives by trading complex financial instruments called derivatives.
Traders could use single-stock ETFs to double down on their short-term bets on companies such as Apple, says Malcolm Ethridge, a certified financial planner based in Rockville, Maryland and vice president of CIC Wealth.
However, Ethridge points out that single-stock ETFs are not long-term investments.
“It’s an overnight strategy, ticker by ticker. They’re not meant to be bought on Monday if you plan to hold them until Friday,” he says.
What’s driving the single-stock ETF trend?
Will Rhind is the CEO of GraniteShares, a New York-based ETF issuer that has launched several single-stock ETFs. He says the single-stock ETF trend is driven by the popularity of leveraged ETFs overseas and recent regulatory changes.
“We intend to do a bunch of these products on various companies,” Rhind said. “We’ve been doing this in Europe for a few years – that’s sort of where the idea started.”
“There were only two companies authorized to issue leveraged products [in the U.S.] until a few years ago, and it was ProShares and Direxion,” says Rhind. “That changed with the new updated rules that came out a few years ago.
Ethridge agrees that regulatory changes played a big role in the rise of single-stock ETFs, but he takes a different view of where the trend is coming from.
“I think it’s trying to meet the market where it was in 2020,” he says, referring to the trend at the start of the pandemic era of stock and options trading memes.
“Robinhood, by allowing ordinary people to invest in options, has awakened [Wall Street] down to the fact that ordinary people want to be able to invest that way,” says Ethridge. ‘t have permission to do so.
Should you buy single stock ETFs?
Advisors are hesitant to recommend single-stock ETFs because of their risky nature.
“These types of instruments are not for the faint-hearted,” says Frank Paré, a certified financial planner based in Oakland, Calif., with PF Wealth Management and former president of the Financial Planning Association.
“I wouldn’t recommend it to an average investor. I wouldn’t recommend it to a long-term investor. I wouldn’t recommend it to an investor,” Paré says. “I would recommend it to those who like to speculate and have a high tolerance for risk.”
Ethridge also believes single-stock ETFs have many potential downsides. “Because of all the leverage involved, things can go wrong very quickly,” he says, adding that fund fees “will likely erode any positive returns.”
The United States Securities and Exchange Commission has expressed similar concerns. He warned investors that the returns of these ETFs can deviate from their targets over time due to their complicated internal workings.
“Daily rebalancing and compounding effects can cause returns to diverge quite significantly from the performance of, in this case, an underlying stock, particularly if these products are held for multiple days or longer,” SEC Commissioner Caroline Crenshaw wrote in a statement. on the SEC website in July 2022.
Paré says he thinks most people would be better off avoiding single-stock ETFs and relying on proven strategies to build wealth.
“Follow the slow, boring path of steady returns over a period of time, rather than speculating in the market,” he says. “If you feel you need [speculate], do it in a responsible way; take a very small part of your wallet.”
Neither the author nor the publisher held a position in the aforementioned investments at the time of publication.