ETF Edge - The leverage explosion 2/24/25

Episode Date: February 24, 2025

Leverage, inverse and single-stock funds have exploded in popularity. But, could a turn in the market leave some investors imploding? What to know before you buy into this trend.   Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

The ETF Edge podcast is sponsored by Invesco QQQ, proud provider of access to innovation for the last 25 years. Investco Distributors, Inc. Welcome to ETF Edge, the podcast. If you're looking to learn the latest insights on all things, exchange, traded funds, you are in the right place. Every week, we're bringing you interviews, market analysis, and breaking down what it all means for investors. I am your host, Bob Pisani, leveraged, inverse single-stock ETFs. They've been exploding in popularity, but could have turned in the market, leave investors implode. What to know before you go into these products.

Very interesting discussion with Doug Gionis. He's the CEO of Direction, along with Todd Rosenbluth, the head of research at Vetify. Doug, I presume everybody knows, you are one of the largest providers of leverage and inverse ETF products. Every day I look at the volume charts. I see your semiconductor bull ETF. It's always up there in the dollar volume charts. It gets three times the return of the semiconductor index.

Those of you don't know that on the daily basis. Your 3X S&P 500 always shows up on the volumes. Just tell us who's doing all of this trading. The volume really has notably moved up in a while. Who's doing it? Give us a sense. Volume and assets. I mean, the reality is it's no surprise to me that you're seeing the direction lineup of

ETFs on the chart in the top 10, top 20 ETFs traded every day. Those out there, you know, we think, when we try and measure this, we think about three quarters of the folks trading are retail, and another quarter is instituted. And you know, it's interesting when those are look, you know, there's varying use cases for why you would want these leveraged ETFs. They tend to be all short term in nature, which is I believe there are some news coming out that I want to trade around. We've got NVIDIA results coming out Wednesday, right? There'll be a lot of movement and traffic there. Could also be reactionary to what we're seeing in terms of headlines.

Could also be, you know, as simple as a trade desk or an individual saying, I want to hedge my position. You know, we have a lot of securities in the market that are that are up a lot of last five or 10 years, market seemingly has been going sideways. We saw Friday's correction. There are people out there that are saying, hey, maybe I don't want to be fully invested, but I also don't want to take the capital gain on selling a position. What can I do? I can take a long position in a short ETF and inverse ETF. I can basically neutralize my exposure. I want to put up that full screen we just put up, who's trading leverage in inverse ETS? Because there's an interesting point you're bringing up here. You say about 12 to 15 percent of the volume

comes from outside the US. South Koreans, you mentioned. I've heard this before from the 24-hour-a-day exchange people. South Korean, Jung South Korean, Japanese, who are these people? You're right. You know, it's hard to measure again, but, you know, thumb in the air, we think somewhere between 10 and 12% of the assets and all these leveraged and inverse CTFs are coming from outside of the U.S. The use cases are often the same, but a lot of times it's often, you know, investors who want to participate in the U.S. markets. There's a lot of news coming out of the U.S. markets. There's also been a lot of growth out of the U.S. markets.

And so if you're an investor outside of the U.S., at particular, a lot of these Asian-based countries, they do have access to the U.S. market through the New York Stock Exchange. They can trade ETFs and securities that are listed here at the New York. And Todd, one of the things that's amazing is when I talk to people about this,

these people overseas, they have kind of flatish markets. And they're watching, you know, on TV, They're 12 hours away, and yet they seem to want to try to participate. This is sort of part of the impetus around the 24-hour trading story, you know, oh, foreign traders. It's quite remarkable to watch this kind of level of interest. I gather their local markets aren't as interesting, and so they try to figure out they're very, shall we say, not risk-averse necessarily. They seem to be quite eager.

Well, the biggest and strongest companies, many cases are in the United States, whether they're technology companies, Apple and Microsoft, Nvidia, or their other growth-oriented companies that you can find single-stock leverage ETF. So we're finding more and more investors, retail, as well as some advisors that are learning about ETFs because through the individual stock, and then they're getting the benefits of diversification

and liquidity that they can get through that ETF wrapper. So when you talk about institutional investors, you said about 25% of people here are institutional. You're talking about a broad swat, like hedge funds, trading desks, large brokerage firms. Yes, yes, and yes. I mean, there are a large amount of institutions. There's even, you know, how you categorize registered investment advisors, they might have a sleeve of assets that they have for very aggressive positioning, and they'll use leveraged

and inverse ETSs. But going back to large head funds, those that are really reacting and want to try and pre-react to a lot of the market news out there, they want to take short-term positions on individual companies and they also want to do it on the overall market. It could be semiconductors. It could be the banks. It could be home builders. There are a lot of market moving headlines happening every day. So in institution, it could be anybody who has a book of positions that wants to be neutral to market. That's right. Or even if you think about a trade desk, right, there are folks that are surrounding us here on the exchange floor that have large positions in a lot of securities.

They might want to neutralize their risk or let's say they're short the market. They need to bring that back to zero and they'll do that using the direction lineup of ETS. Todd, the assets in leverage inverse products are becoming a larger part of the whole ETF universe. This is what's interesting to me. I mentioned 2% of assets in 2016. It's 8% today. I know direction in pro shares.

They're sort of neck in-neck in terms of the largest ETFs in the space. I look at Pro-Shares, Ultra Pro QQQ, this competition here, TQQQQ. There are three times leverage, 3x leverage exposure to the NASDAQ-100. Stack 100, $26 billion. Look at this in assets here. Single stock ETFs that leverage Nvidia and Tesla are also really big. There's direction semiconductor bull 3X, almost $9 billion. And like I said, it's not just leverage an inverse index ETFs.

The single stocks leverage the ETFs. They're growing fast as well. There you see long Nvidia. There's long Tesla that are there. These are among the heaviest volume ETFs out there, two-time long Nvidia as well. as well. Comment on this. I mean, what, yeah.

It's remarkable to me to see the assets growing. Now you can say, well, yes, there's a certain bull market effect here. So the assets under management tend to go up. But even the average daily trading volume has been going up, the dollar volumes have been going up. And the assets under management are going. So all the metrics, you can't just say, well, the markets overall is going up. Therefore, no surprise here. Right.

The leverage and inverse industry has evolved. So TQQQ was the first of those ETFs that I can recall, 15 years old. But as you showed on the screen, Direction, pro shares, others now have single stock leveraged ETFs that have become very successful. And single stock leverage ETFs probably sounds hard to wrap your head around, but it's one stock you get the risk on or in case of inverse risk off exposure to that and the liquidity benefits of the ETF wrapper. So we're seeing more investors turn to that at our website.

sites, ETF trends, and ETF database, we get disproportionate of our traffic towards our leverage and the inverse channel because people want to learn about individual stocks, learn about the ETF exposure to that, and so the volume and the interest is perhaps even stronger than that asset base. You know, you can slice and dice this a lot of ways, but what I have noticed every day is of the top 20 ETFs by dollar volume, it's usually five or six that are in the top 20 right now. So the pro shares ultra pro triple Q your daily semiconductor bowl always shows up in the top top 20. Your Tesla bowl TsLLL is the symbol there always shows up in the top 20. Pro shares ultra pro short QQ, granite shares long Nvidia. These show up routinely in the top 20 ETX right. I mean the

reality Bob is the the markets today they are direction weather right it's not the old days where we We wait for an earnings report, we see if there's some growth, we wait for the CPI or PPI to come out. There are market moving headlines happening two to three times a day, and so the volatility is growing up, not down. And we think that holds for the whole year. So if you're a hedge fund, if you're an individual trader or you're an RIA, you're probably needing to react to that in some way.

And so it's no surprise to me that those with short-term investment views are going to play that out in the form of a leverger and inveter CTF. Right. I'm going to do 30 seconds of nerdiness, okay? I always do this. You've got the right crowd here for that. Can you explain how you get the leverage briefly? I mean, we usually say, oh, they use futures and swaps and options.

But for example, how does the 3X semiconductor actually get that? Yeah, I mean, you brought it up and we'll be nerdy for just a few seconds here. 30 seconds. All of our ETFs that are using leverage, we do it through the form of what's called a swap. So you're basically going to an institution, a bank, and you're saying, hey, I want you to give me back the performance of 3x semiconductors for one day. And the swap is intricate. There's money movement.

There's collateral. There's things to make sure that it's safe and done through clearing. But at the end of the day, basically, you're getting the performance as named. Now, you did note there are some of these ETFs out there that don't get full performance coverage through a swap. They're doing it through options. They're doing it through futures. It could be they don't have the relationships.

It could be they just don't have access to the banks. And you're seeing, and we saw the headlines, some of those ETFs not able to reach the beta they want to perform. So for the direction lineup of ETFs, we make sure we're hitting the performance. Is that an issue not getting the performance? It is. So he's not going to refer to his competition, but we've seen some strategies. But you can. Yeah, but he can.

We've seen micro strategy is a stock that we have single stock leverage ETFs. And that's not a large stock. So it's not Apple. It's not Invidia. And so we did see some of those ETSs that were leveraged, tied to that, they couldn't deliver that exposure through a swap. They had to use other means. That offers a different experience for the investor. So it's important to also know who is behind the firm, behind the ETF. You kind of do a lot of homework here. What happened to just buy the S&P 500?

You've been saying it for years, right? You've been saying it for years. It's about education. That's right. This is about education, Bob. I mean, you've said it for years. We'll say it again. You need to learn about how these ETFs work. You need to understand daily leverage. You need to understand the daily reset. We provide a lot of this education on our website, directionetfs.com. VETify does as well, but you're right. You need an investor that's out there that's not an institution, they're not a hedge fund, they need to go and learn exactly how they work. But it's become even more complicated. So the broad S&P 500 or NASDAQ 100 or that, you should have more confidence in using those leverage and inverse ETFs to know that there's enough liquidity.

The liquidity of the underlying stock market or the S&P 500 or the NASDAQ 100 is quite strong. It's when we get into these single stocks that are not mega-cap stocks, the risk becomes greater. Well, you brought up the daily reset. So here we go, folks. The annual, let's explain the daily reset here. So retail investors have had a very hard time getting their head around these products because of this daily reset, folks. So what happens if you don't know, they reset every day. So if you hold them for more than a day, your returns may vary wildly because of what's called compounding effects.

So Todd, how would you grade the ETF leverage in inverse industry for educating investors about this critical aspect? Are people better educated than before? Remember we used to do this seven or eight years ago. People could not get their head around the Daily Reset. So I think investors are better educated. Those have been using these products are better educated.

Doug's firm, other firms that are established within this space, have done a good job of educating. And on their website, you can be able to see that information. The challenge I have is that many folks are not visiting the website of an asset manager or they're not visiting our website where we have education content. They're just going on to their brokerage account or on their phone even and just buying something because it is a single stock leverage ETF and thinking they're going to get two times a return of Nvidia when Nvidia reports results today. It's a little bit more complicated

than that. So before you buy anything, go go to the fund website, see what they'll tell you. Yeah, I want to give you all, this sounds very difficult to get your head around, but I want to give you a very simple example of how it goes different than your expectation. So let's take an example of you put $100 into the S&P 500 over two days. We have a full screen that explains. Say it's $100 and say one day it's up 10% and the next day it's down 10%. So on $100, on the end of the first day you have $110, right? And then it's down another 10% the second day and you have $99. Okay. So there's a typical example of what would happen if you would think that you're just owning that. Now, if you're two times leverage, you think you might be down

2% there. But in fact, it doesn't really work that way because of the compounding effects. So here's the $100. Here's what you have two times leveraged. At the end of a day, you have $120 of your move 10% in the S&P 500. If you're leveraged two times, you have 20% return. So now instead of $100, you have $120. That makes sense, right? Now let's just say the next day, you're down 10% and instead of your loss is 20% because it's 2x. So you actually have 120 times 0.8, you have $96 here.

You would think that you would only have $98 if you're down, but you actually have $96. This is an example of compounding and it gets fiendishly more difficult. This is the simplest example I could come up with. It gets fiendishly difficult when you go into several days. So this is a simple way for you to understand. It doesn't necessarily work. And when the momentum is going in your direction, you're fine.

When it starts getting choppy, then things get really weird if you hold it. That's why it's so important. I mean, you look at the name of every single one of these ETFs. They say daily in them, and it's so, so important. I mean, education is key. Every investor that's using these should know exactly how they work, and they should be looking at them every single day, hence daily. Yeah, so the point here is essentially, Todd, that these ETFs can systematically

underperform over time. This is what we're trying to get across folks. The other issue is they, as you heard here from the bug, they need to use derivatives to get their leverage. So in some cases you can have things like options decay, futures need to be rolled over, this is why it gets really complicated to sort of explain this to people, have them understand what kind of products they're getting. The one thing that's encouraging to me, we were talking to my friends of Granite shares, they said 30% of their fund turns over every day. That's a sign that people aren't, people aren't sitting on this for days and days.

I think the education may be getting better. That's what I'm trying to get. That's right. I mean, you know, it's hard to see all the data, but everything we see tells us the velocity's there. You, you, in this type of ETF, you would expect a lot of turnover, a lot of velocity of holdings, and that's what we're seeing. But again, education is key. Daily reset, daily checking, come to directionethefs.com, learn how they work. And you have a little explanation, you have an explainer on your website. We do. We have it. education we've got a series of resources we also sponsor a channel on VETify so VETify.com another place for education but reach out to us we're friendly

people we'd love to get on the phone and explain how things work and your concerns seem to be not so much of the index but single-stock ones and what your advice again to people concerning single-stock ones is just go and look at how the fund has performed on the website in that period of time before you purchase it and is that experience what you would expect it to be if it is and you're comfortable with that level of volatility, then it could be for you, for the day. Is there any situation, I know I'm putting on the spot here, Todd, but is there any situation where this could be a systemic risk where all of a sudden it's, it's, it's video's earning

so there's massive positions in this thing? Could there be a systemic problem somehow? I'm not- Remember the volatility ETFs of 2018? Right. So I'm not concerned about Invidia. I'm concerned about those smaller stocks if there becomes increased popularity in getting exposure using single stock leverage ETFs. Then you have disproportionate share connected to one ETF and connected to the leverage behind it. That could be a greater risk.

Invidia, the amount of money that is owned by ETFs in general, let alone leverage and inverse ETFs of Nvidia is still quite small. I'm not concerned about earnings coming up this week. Yeah, I mean, we've talked almost all bulk case here, but it's also important to talk about bear cases. We saw a market sell off on Friday. A lot of investors are starting to look at the inverse ETFs. They're negative one ETFs in the direction line up, right?

So you're not necessarily dealing with the leverage factor, but it does give you a way to remove exposure without taking some capital gains. And when you look at the MAG7 stocks, I think six of the seven right now are down this year. There are individuals who are saying, how do I hedge my position? And inverse ETFs can be a way to do it without leverage.

And of course, all of this is really a manifestation of risk on behavior that we see. We've seen more explosion in options, zero data exploration options. This is a sort of a manifestation of the, of the, I won't call it a speculative fever. I just did. But that's been out there, right? I mean, it's not just an isolated case here. This is a risk-on environment for investors in general,

ETFs are providing access to that risk-on nature or in the case of what Doug is talking about, the risk-off nature. So you can certainly short an individual ETF yourself. or you could use an inverse ETF, which is easier to be able to do. And so Douglas' firm direction offers that as an opportunity. Now it's time to round out the conversation with some analysis and perspective to help you better understand ETFs. This is the Markets 102 portion of the podcast.

Todd Rosenblumptu, head of research at VETIFI continues with us now. Todd, great discussion on leverage and inverse, but I just want to talk about a few ETF items. We made a big thing last week. Vanguard's S&P 500. ETF, V-O-O, sort of passed and sort of equal to the famous Spider, S&P 500. They both have about 630 billion in assets under management, so let's not quibble too much about who's ahead.

The important thing is, why did that happen? Just explain that to us. Yeah, well, first, let me say on air, happy birthday to you, Key milestone as well, for those of us within the ETF industry. Another year round for you. But yeah, Vanguard catching up to start. spy VOO that to me is a key milestone because what we've seen is the ETF industry has shifted from just more geared towards institutional

investors and more towards retail and wealth managed advisors those investors that are owning VOO are more buy-and-hold oriented more strategic as opposed to short-term and tactical and the ETF industry all investors benefit when there's more investors focus on it the trading volume goes up across the So we expect that Vanguard is going to stay Eclipse and be number one in the 500-based products, and that's going to continue to accelerate. And we'll see more investors build portfolios around the S&P 500 using the Vanguard strategy. But simply put, it's a basis point story.

SPY, the Spider-S-NP-500, it's nine basis points. Vanguard, V-O-O-O is three basis points. And so is the I-Share's S&P, which is IVV, also the same. So in a sense, it makes some sense for investors long term, even for six basis points, to slowly go into either V-O-O or IVV. Right. We were just talking about leveraged in inverse ETFs. And if you're trading those as you should on a daily basis, then the expense ratio doesn't

matter the same way. If you're owning spy for the long term, that nine basis points eats up. But it's funny because Spider or State Street, which owns it, has a cheaper one. That's three basis points. It's actually two basis points. SPLG, which is the Spider portfolio S&P 500 ETF. So yes, if fee is the only thing that matters to you, there's a cheaper alternative than spy three different ways. If liquidity is what matters to you, the trading volume and spy is still by far the best.

And I see that every day. Invariably, spy is the most, by dollar volume, it's the most actively traded because I gather a lot of people use it for tactical trading. They do. Either it's institutional investors, hedge funds, large asset managers, or it is RIAs that are being very tactical with their trading. If you're a retail investor and you're listening to this, there's probably a better, in fact, there is a better alternative to spy if you're planning on holding this for days, weeks, months, even years. And that can come from State Street for two basis points or Vanguard or I shares for three basis points. Yeah. Once again this year we see actively managed funds a significant portion starting out the year. This was the big story last year. Is there any specific kind of active though? There's active plus or index plus where you're getting just the companies that are out there that are essentially doing indexing with a little bit of active management thrown in. and then there's others that are just much more hands-on in terms of their management.

Right. So the firms like Avantis or Dimensional Funds are still having a lot of success with their index-like actively managed strategies. They own the broad market, but raise the levers up and down a little bit for a single security based on quality and value and size. But we are seeing some other firms. Janice Henderson has J-Tri-A that is a CLO-E-T-F that continues to pull in new money. CLOs is an area of the marketplace you don't get exposure to in your

aggregate bond index less interest rate sensitive a unique part of the marketplace. We're seeing Capital Group. They're actually hitting their three-year anniversary of offering ETFs today as we're recording this and a product like the Capital Group dividend value ETF close to $15 billion in assets just hitting its three-year birthday so people are buying more stock picking or oriented value strategies or some of the growth strategies. Tiro Price has had success with some of their actively managed UTIFs. We are seeing some of the bottom-up stock picking, not all of it,

but some of that bottom-up stock picking and bond picking that you tend to think of with actively managed strategies. And you guys have a big conference coming up. I'll be there. The exchange conference will be in Las Vegas at the end of March. Tell us about that. Yeah, we're really excited about it. We've got close to 700 and counting financial advisors with valid CRDs.

of industry folks are going to be there. Three-day event that takes place March 23rd through the 26th. You're going to be there. I believe you're going to be doing your show, ETF Edge from there, as well as interviewing Rob Arnott on stage. We've got lots of active managers that are going to be on stage Tiro Price and Cohen and Steers are going to be there at TCW. We're going to hear some other industry folks about what's going on in the marketplace. And we're going to do a lot of ETF education for advisors to get them up to speed. There's a lot of people who've entered into the ETF marketplace the last couple of years. The industry is not slowing down.

I have been going to this for 15 years and it's one of my favorite conferences. It's where most of the elite of the ETF world gets together. I'm looking forward to seeing you there, Todd. Thank you very much for joining us. Appreciate that. That does it for ETF Edge, the podcast. Thanks for listening. Join us again next week or remember all the shows on the website, ETFedge.c.c.com.

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