(Bloomberg) -- The arrival of a US investment strategy that offers amped-up stock leverage is putting a spotlight on an industry popular with retail traders, but prone to extreme volatility and frequent blow-ups.
The MAX S&P 500 4X Leveraged ETNs, which launched last week with the eye-catching XXXX ticker, promise to quadruple the daily returns of the benchmark index. That makes them the highest-leveraged trade of their kind currently available to American investors, according to CFRA Research. They charge a fee of 0.95%.
The issuer Bank of Montreal and MAX — BMO’s brand for leveraged and inverse products — say that the exchange-traded notes are intended only for sophisticated investors, who can actively monitor their investments and who understand the potential consequences of buying this type of vehicle.
Still, some market-watchers urge trading caution.
“It seems extraordinarily expensive, risky, and includes a bit of counterparty risk to boot,” Dave Nadig, financial futurist at VettaFi, said of XXXX. “All so you can day-trade faster?”
Exchange-traded notes are a different beast from their fund counterparts that individual investors are more used to. Unlike ETFs, they are unsecured debt obligations, meaning they are backed by the issuer rather than their underlying assets. Since they frequently use derivatives to amplify returns, they are vulnerable to extreme market events. A Credit Suisse ETN was at the heart of 2018’s ‘Volmageddon’ episode. The bank’s oil note was then wiped out two years later when crude prices went negative.
The Securities and Exchange Commission hasn’t limited the amount of leverage ETNs can offer like it did for ETFs — which are capped at two times leverage for new launches. Products offering three-times the leverage that had been launched in the past are still available.
XXXX’s prospectus adds that the ETNs are intended to be used as “daily trading tools” and not meant to be held to maturity.
A spokesperson for the SEC declined to comment when asked about the associated risks with such a product. BMO declined to speak about the vehicle beyond its press materials, and MAX representatives didn’t return requests for an interview.
Wall Street regulators continue to be wary of such products. The Financial Industry Regulatory Authority has called for far-reaching rules to curb retail-investor access to ETNs. SEC Chair Gary Gensler has also warned in the past that these products “pose risks even to sophisticated investors and can potentially create system-wide risks.” Currency ETNs with four-times leverage, issued by VelocityShares, had been previously available in the US.
Demand Outlook
While the ETN structure allows investors to generate big gains on directional debts, it can also lead to swift losses as most are designed to be held for short periods. Retail interest for leveraged products had boomed post-pandemic and have since moderated.
Still, products offering the most amped-up returns remain popular, according to Aniket Ullal at CFRA. ETPs giving three-times leveraged or inverse returns account for roughly 70% of assets and 75% of volume among all such products in the US. In addition, five of the top 10 most-traded ETPs in the US — based on average daily trading volume over the last three months — have been leveraged bets, he found.
But when it comes to XXXX, the timing of its debut may not be ideal since it’s entering a market that has already staged a big rally, said Athanasios Psarofagis, Bloomberg Intelligence ETF analyst.
“Not sure if investors are comfortable going 4x long here,” he said. “You also have several other levered S&P products on the market from ProShares and Direxion that they need to compete with,” he said, referring to funds that trade under the tickers SSO and UPRO that also offer exposure to the benchmark index but have leverage of 2x and 3x, respectively.