In their infinite wisdom, Wall Street’s top shot financial innovators are at it again. The folks at an investment firm called AXS have created a new product… the single equity exchange traded fund.
Unlike traditional ETFs, which provide exposure to a basket of stocks or bonds, single equity ETFs are designed to provide exposure to only one stock. AXS has offered the following 8 products:
What’s the point?
Why would you want to buy a single equity ETF? After all, if you wanted to invest in Nike, you could… uhhh…. just buy Nike’s stock. Well, single equity ETFs not only provide exposure to a single stock, but also use derivatives (call or put options) to provide leveraged exposure to a single stock.
If you REALLY like Nike stock and you think it’s going to go up, then you can buy NKEL, which offers 2X leveraged exposure to Nike stock. And if Nike’s stock goes up 2% in a day, then NKEL will go up 4% (minus fees).
AXS also offers a product (NKEQ) with inverse exposure for those times when you think Nike’s stock will go not up, but down.
What could go wrong?
I have a few, or rather, a lot of problems with these new products. First, they dispense with the whole notion of diversification and offer only concentrated exposure to a single company. Not good.
Second, these products introduce leverage into the mix. Most investors have no business involving leverage in their long-term investment strategies. Even small amounts of leverage can take investing from ‘risky’ to ‘nuclear risky’. Sure, you can amplify your potential gains, but in exchange you must also amplify your potential losses.
Third, these products don’t work the way most people would assume. Like existing leveraged ETFs, single equity ETFs are rebalanced on a daily basis. If your holding period extends over multiple days (or months or years), the returns of the ETF will vary significantly from the returns of the underlying stock. Unfortunately, it’s not as simple as saying, “Well, gee, Nike’s stock went up 10% over the past year, so my leveraged ETF must’ve gone up 20%.” The daily rebalance can degrade your long run performance and often leave a trail of disappointment for many investors.
Fourth, don’t forget the fees! AXS is charging 1.15% per year on these products and that includes their temporary fee waiver.
Fifth, these products can lose money in a hurry. NKEQ, which offers 2X inverse exposure to Nike’s stock, has lost over 20% in less than a month of existence. Many other leveraged ETFs (especially the inverse variety) have lost about 99.99% of their value over time. All it takes is one bad earnings report or economic event, and poof, there goes all your money.
Sixth, these products come across as gimmicks. They don’t really offer a pathway to improved outcomes for investors or add anything of value to the investment landscape. Sure, some investors enjoy making short-term bets on the direction of individual stocks (aka day trading), but there are already plenty of ways to make those bets. You could buy options directly, or use a margin loan to get the required leverage. In my opinion, fund companies should have a laser focus on helping client’s achieve good investment outcomes and achieve their goals more effectively. As I’ve written previously, they often do not.
Seventh, the regulators could crush these things in the future. Needless to say, the SEC does not seem to be a big fan of these products (you can read their statement here). Regulators have good reason for concern when fund companies create gimmick products. And I’m sure they will take a closer look down the road.
I could go on, but I’ll get off my soapbox now. As a takeaway, here is a great quote on Wall Street’s tendency to “innovate”:
Complexity is job security.
Rick Ferri
