Regulators urged retail investors and advisors to show caution when mulling single-stock exchange traded funds, which will enter the market in the coming weeks.
Securities and Exchange Commission Commissioner Caroline Crenshaw reiterated her ongoing concerns about leveraged and inverse ETFs, in a statement Monday, but worried that single-stock ETFs could be “another, perhaps greater, risk” for investors.
“Because of the features of these products and their associated risks, it would likely be challenging for an investment professional to recommend such a product to a retail investor while also honoring his or her fiduciary obligations or obligations under Regulation Best Interest,” Crenshaw said.
A single-stock ETF tracks the performance of one particular stock as opposed to following the peaks and valleys of a certain index. These single-stock ETFs allow investors to go all in on individual companies while sticking to an ETF's typical daily reset (the commission’s previously warned that complex products committed to resetting each day may not be suited for retail customers hoping to hold products for the long term during volatile market swings).
Several issuers, including Direxion and GraniteShares, want the SEC to approve a number of leverage and inverse single-stock ETFs this year; in February, Direxion filed for funds tied to particular stocks like Meta, Netflix, Apple, Amazon and others, according to CNBC. GraniteShares wants nearly 20 funds tied to Coinbase, Palantir and Tesla (as well as another fund offering Tesla’s inverse). AXS also offers a Tesla-tied fund, among others, and filed paperwork with the SEC indicating it received the necessary regulatory approval, according to Bloomberg.
Despite some similarities, holding a leverage or inverse single-stock ETF could be riskier than the stock itself, a traditional ETF or even a complex ETF tied to an index, as the product can become riskier the longer it is held and these funds sacrifice diversification by tying their success to a single company, according to Lori J. Schock, the director of the SEC’s Office of Investor Education and Advocacy.
“Because leveraged single-stock ETFs in particular amplify the effect of price movements of the underlying individual stocks, investors holding these funds will experience even greater volatility and risk than investors who hold the underlying stock itself,” she said.
According to Crenshaw, single-stock ETFs are launching “under the auspices” of a rule the commission passed in 2019 that created a framework allowing certain ETFs to more quickly make it to the market. Crenshaw argued the rule change made the introduction of the single-stock ETFs possible.
While Crenshaw argued advisors would find it difficult to meet their fiduciary responsibilities when recommending such products, retail investors would still be able to access the products via self-directed trading.
“While investors can gain similar upside and downside exposures to an equity security through the use of options and other derivatives, single-stock ETFs are likely to be uniquely accessible and convenient for self-directed retail investors, in particular,” she said.
Crenshaw lauded the Financial Industry Regulatory Authority’s call for public comment earlier this year on updates to its rules on complex products, in which the regulator argued that “important regulatory concerns arise” when investors trade such products without fully understanding the risks. But Crenshaw believed a comprehensive review of these products by the commission was “long overdue.”
“Further, with respect to single-stock ETFs in particular, I am disappointed that the commission has thus far failed to make use of the tools it does have ... to grapple with the question of whether these products are appropriate in the public interest and consistent with the protection of investors,” she said.