Investors in the U.S. now have access to single-stock exchange-traded funds (ETFs) that offer amplified and inverse returns on the daily performance of individual stocks. But the securities have caught the attention of experts and regulators, who warn that these new funds present significant risks for most investors.
Here’s what you need to know about single-stock ETFs and the risks they come with for investors.
Single-stock ETFs use derivatives to provide leveraged and inverse returns on individual stocks.
For example, say Tesla (TSLA) is reporting earnings and you’re particularly bullish or bearish on their results. You might buy the stock or short the stock to potentially profit off your views. But single-stock ETFs now allow you to magnify the potential return by aiming to double the stock’s daily return or provide double or 100 percent of the inverse return, bringing sophisticated trading vehicles into the hands of everyday investors.
In other words, single-stock ETFs give you access to leverage that would normally require approval from a broker for margin accounts or options trading.
“Single stock ETFs are highly speculative and intended to provide geared exposure to individual stocks,” says Bryan Armour, director of passive strategies research at Morningstar Research Services. “The stated amount of leverage or inverse exposure is reset daily, meaning these are short-term vehicles not intended to be held over long periods.”
AXS Investments has launched a handful of single-stock ETFs based on companies such as Nike (NKE), Tesla, Pfizer (PFE) and PayPal (PYPL). GraniteShares, another fund company, soon followed with its own batch of single-stock ETFs in August 2022.
The funds have been allowed to move forward thanks to a 2019 Securities and Exchange Commission (SEC) decision, allowing ETFs meeting certain criteria to come directly to market without first obtaining permission from the SEC.
Risks of single-stock ETFs
Single-stock ETFs present several risks for investors to be wary of including:
Returns on the fund over periods longer than one day may diverge significantly from the performance of the underlying stock because of daily rebalancing and the effects of compounding.
Since the funds are focused on just a single stock, investors won’t get the diversification benefits that are available through more traditional ETFs that hold stocks across different sectors of the economy.
The short holding period these funds are intended for means they’re geared more towards traders and not long-term investors.
Fees on single-stock ETFs can be meaningfully higher than the fees on traditional ETFs, such as an S&P 500 index fund.
In August 2023, the SEC released an updated investor bulletin warning consumers about the risks of single-stock leveraged ETFs, noting that “investors holding these funds will experience even greater volatility and risk than investors who hold the underlying stock itself.”
Rob McDougall, vice president of investment strategy at Zhang Financial, said the new funds aren’t likely to be a fit for typical investors.
“We would not consider these products for use in our wealth management practice,” McDougall said, instead preferring to hold mutual funds, ETFs or stocks for multi-year periods. “These levered and inverse ETF positions would need to be managed on a daily basis.”
Bottom line
In the end, single-stock ETFs are best used by sophisticated traders and investors who understand the risks involved. If you’re like most investors who are saving for long-term goals such as retirement, single-stock ETFs aren’t going to make sense in your portfolio. Instead, stick with diversified funds that track broad market indexes and keep costs low for investors.
– Bankrate’s Rachel Christian contributed to an update of this story.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.
In finance, a single-stock future (SSF) is a type of futures contract between two parties to exchange a specified number of stocks in a company for a price agreed today (the futures price or the strike price) with delivery occurring at a specified future date, the delivery date.
https://en.wikipedia.org › wiki › Single-stock_futures
ETFs present several risks for investors to be wary of including: Returns on the fund over periods longer than one day may diverge significantly from the performance of the underlying stock because of daily rebalancing and the effects of compounding.
While an ETF sounds like a simple “single” investment, it comes with enhanced risks; including lack of diversification, daily resets, leveraged structure, active trading needs, and compounding losses.
ETFs are less risky than individual stocks because they are diversified funds. Their investors also benefit from very low fees. Still, there are unique risks to some ETFs, including a lack of diversification and tax exposure.
A single-stock exchange-traded fund allows you to leverage a single company, and potentially earn a significantly higher return. Sam Taube writes about investing for NerdWallet. He has covered investing and financial news since earning his economics degree from the University of Maryland in 2016.
There are many ways an ETF can stray from its intended index. That tracking error can be a cost to investors. Indexes do not hold cash but ETFs do, so a certain amount of tracking error in an ETF is expected. Fund managers generally hold some cash in a fund to pay administrative expenses and management fees.
Cons include more difficulty diversifying your portfolio, a potential need for more time invested in your portfolio, and a greater responsibility to avoid emotional buying and selling as the market fluctuates.
Experts agree that for most personal investors, a portfolio comprising 5 to 10 ETFs is perfect in terms of diversification. But the number of ETFs is not what you should be looking at.
Investing in an ETF that tracks a financial services index gives you ownership in a basket of financial stocks versus a single financial company. As the old cliché goes, you do not want to put all your eggs into one basket. An ETF can guard against volatility (up to a point) if some stocks within the ETF fall.
ETFs may close due to lack of investor interest or poor returns. For investors, the easiest way to exit an ETF investment is to sell it on the open market. Liquidation of ETFs is strictly regulated; when an ETF closes, any remaining shareholders will receive a payout based on what they had invested in the ETF.
Leveraged ETF prices tend to decay over time, and triple leverage will tend to decay at a faster rate than 2x leverage. As a result, they can tend toward zero.
Interest rate changes are the primary culprit when bond exchange-traded funds (ETFs) lose value. As interest rates rise, the prices of existing bonds fall, which impacts the value of the ETFs holding these assets.
ETFs offer advantages over stocks in two situations. First, when the return from stocks in the sector has a narrow dispersion around the mean, an ETF might be the best choice. Second, if you are unable to gain an advantage through knowledge of the company, an ETF is your best choice.
There are now nearly four dozen single-stock ETFs in the U.S., many of which track the so-called "Magnificent Seven" stocks — Apple , Microsoft , Alphabet , Nvidia , Amazon , Tesla and Meta . Other names on Morningstar's list of single-stock ETFs include Coinbase and Alibaba .
ETFs offer numerous advantages including diversification, liquidity, and lower expenses compared to many mutual funds. They can also help minimize capital gains taxes. But these benefits can be offset by some downsides that include potentially lower returns with higher intraday volatility.
However, individuals opting for a single equity ETF must be cognizant of the inherent risks and volatility within the equity market. Always consider your risk tolerance and investment goals before making a decision.
Diversification: ETFs generally offer instant diversification as they hold a basket of securities across various industries or asset classes. This diversification helps reduce risk compared to investing in individual stocks, which can be more volatile and concentrated in a specific company.
When you take on more systemic risk — the risk inherent to the market at large — you are rewarded with higher expected returns. However, you are not compensated for idiosyncratic risk, or the risk associated with an individual company.
Liquidation of ETFs is strictly regulated; when an ETF closes, any remaining shareholders will receive a payout based on what they had invested in the ETF.
Introduction: My name is Tyson Zemlak, I am a excited, light, sparkling, super, open, fair, magnificent person who loves writing and wants to share my knowledge and understanding with you.
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