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AXS files to launch weekly, monthly and quarterly leveraged ETFs
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A US manager has filed to launch the first leveraged and inverse exchange-traded funds, designed to reset over longer periods, offering a solution for investors who risk losing if they intend to hold their titles for more than a day.
The lineup of 50 ETFs offered by New York-based AXS Investments would offer weekly, monthly and quarterly resets on 2x long exposure to a dozen ETFs managed by competing issuers, which track underlying exposures such as S&P 500, Nasdaq 100, bitcoin, Nvidia and Tesla. Similar duration short exposure would also be available on some of these ETFs.
There are already about 150 leveraged and inverse ETFs in the United States, with total assets of $94.9 billion as of the end of April, according to data from Morningstar Direct. Some products have proven extremely popular, with 3x Nasdaq ProShares UltraPro QQQ (TQQQ) currently holds $22.4 billion.
However, because all of these products reset daily, they suffer from what is called volatility slowdown (see below). This means that the longer vehicles are held and the greater the volatility, the more likely it is that performance will deteriorate.
AXS’s proposed ETFs, which would be branded Tradr ETFs, would circumvent this problem for those who held them during the stated reset period, although volatility would continue to set in after that point.
“We analyzed a lot of data. Investors hold daily reset ETFs for more than a day, sometimes a week, a month and we have received anecdotal feedback from clients of other firms sometimes for a year,” said Matt Markiewicz, Head of Product Markets and capital at Tradr ETFs.
“They experience this volatility drag that is common to all of these products. There is a massive need for products with a longer reset.
William Trainor, a finance professor at East Tennessee State University who has studied the impact of different rebalancing periods, broadly agrees. He has daily rebalancing described as a “major disadvantage for investors with longer-term horizons.”
“Personally, I prefer the monthly [reset]. It’s a little less volatile, especially if you’re a long-term holder. For holding periods of six months or less, I think monthly is much better than daily,” Trainor said.
Its monthly versus daily analysis suggests that “the benefits dissipate significantly beyond six months.” A quarterly reset period should help push this limit further, although Trainor fears that “funding costs will be much higher” for such ETFs, given that issuers typically use swap contracts to achieve the effect of necessary leverage, which involves providing guarantees. with the swap counterparties.
Another problem, Trainor said, is that the exact 2x leverage would only apply to those who purchased a product as soon as it reset. Anyone buying during a reset period will either get less or more leverage, depending on whether prices have risen or fallen in the meantime.
Nonetheless, Trainor was “intrigued” by the quarterly inverse fund reset that Tradr ETFs is proposing to launch on ETFs tracking the S&P 500, Nasdaq 100 and NYSE Semiconductor Index.
“They could be useful to the extent that daily short funds are destroyed by market fluctuations,” if held for a period of time, he said.
“Blocking in a quarter of -2x with no decay due to theft can actually make this fund useful for hedging, meaning if the market goes down, you can guarantee a gain with -2x,” Trainor said.
“Usually, the volatility that increases when markets are falling blunts gains. Any person holding [daily resetting inverse ETFs] for over a week, it’s crazy.
There are a handful of U.S. domiciled mutual funds that use monthly rebalancing.
Guggenheim Investments has run a Nasdaq-100 2x monthly rebalancing strategy since 2014. Direxion manages seven mutual funds, launched between 1999 and 2016, which deliver between 1.2x and 1.75x the S&P, Nasdaq, Russell 2000 Index small cap and the Solactive High. Yield Beta Index, as well as bullish and bearish exposure to Treasury bonds.
The Guggenheim fund holds just $778 million and Direxion’s $615 million between them, but the prevailing view is that most people who use leveraged and inverse products have migrated to ETFs.
Investors have a “growing preference for exchange-traded products over mutual funds, especially given the transparency, intraday liquidity and tax efficiency of the ETF wrapper,” Markiewicz said. High minimum investments can also be a problem for some mutual funds, he said.
This could suggest that AXS may have more success in raising assets through ETFs. However, there remains another obstacle.
Direxion applied to launch its own monthly reset ETFs in 2010, but withdrew its applications. It is believed that at the time the United States Securities and Exchange Commission was uncomfortable with this concept.
However, the adoption of the Derivatives Rule (limiting funds to 200% leverage) and the ETF Rule (which facilitated the creation of new ETFs) in the subsequent period may -be helped to pave the way for a monthly reset of funds.
Despite the introduction of these rules, Markiewicz argued that leveraged and inverse ETFs “haven’t really evolved much” since their emergence in 2006, with the exception of the launch of single-stock ETFs in the United States. United in 2022 – launched by AXS, which manages $1.1 billion in mutual funds and ETFs.
If approved, the first ETFs are expected to launch on August 1, with monthly versions launching first.
What is volatility trail?
The volatility effect affects all investments, but is particularly problematic when the underlying security is volatile, which is more likely for leveraged or inverse exposures than for simple investments that track their underlying assets on on an individual basis.
The following scenario helps explain how this works: if an investment increases by 60% in one period but then falls by 40% in the second, this may look positive overall. However, an investor would have actually lost 4 percent: $100 initially became $160, before falling to $96 after the second period.
This divergence occurs because of an inherent asymmetry: a negative return has a disproportionately larger negative effect compared to a positive return of the same magnitude.
To illustrate how this might work in real life, Professor William Trainor ran 20,000 simulations based on an underlying index that rises between 8 percent and 12 percent over a year with standard deviation (a measure of volatility ) by 40 percent. .
An unleveraged fund thus has a guaranteed return of 8 to 12 percent. However, despite the index rising over the year, Trainor found that a 2x leveraged fund (with a daily reset) had an average return of just 3.1 percent. Returns from individual simulations varied widely, ranging from a 5 percent loss to a 10.5 percent gain.
A 3x daily reset fund fares even worse, with an average return of minus 17.7 percent. Returns ranged between -32.5 percent and -3.7 percent, ensuring a loss.