July 28, 2022
AXS Investments recently became the first fund sponsor to issue single-stock ETFs in the United States, as the SEC declared registration statements effective for 18 such products. (AXS launched a suite of eight products).
The ETFs track popular stocks like Tesla, Salesforce, ConocoPhillips, Boeing, Wells Fargo, Pfizer, Nike, Nvidia, and PayPal. Single-stock ETFs use derivatives to take a leveraged or inverse position on a single security, amplifying the performance (or inverse of that performance) of the stock for the funds. Due to the derivatives risk management program rule, this means a large portion of the fund’s holdings are in high quality collateral posted for the swap.
While single-stock ETFs are already available in Europe, U.S. regulators have been hesitant to approve them. In a July 11 statement, SEC Commissioner Caroline Crenshaw expressed concerns about the risks single-stock ETFs pose for investors and the markets. She noted, among other things, that daily rebalancing and the effects of compounding might cause longer-term returns of single-stock ETFs to be substantially lower than an investor would expect based on the performance of the underlying stock, particularly if the funds are held over multiple days or in volatile markets. She cautioned that it would be challenging for advisers to recommend single-stock ETFs to retail investors while still fulfilling their responsibilities as fiduciaries or meeting their obligations under Regulation Best Interest, given the product’s high complexity and associated risks. Ms. Crenshaw urged her fellow commissioners to pursue rulemaking that would address investor risks posed by single-stock ETFs.
Lori Schock, director of the SEC’s Office of Investor Education and Advocacy, released a statement cautioning investors about the funds’ objective to deliver returns over extremely short time periods – typically, one day -- and the risks that emerge for investors who hold funds for longer periods. Ms. Schock also noted the lack of diversification in a single-stock ETF compared to an ETF that tracks an index and warned that investors holding the funds would experience greater volatility and risk than those who hold the underlying stock itself.
On the other hand, sponsors of single-stock ETFs note the increasing sophistication of retail investors and highlight potential benefits for investors who use single-stock ETFs instead of shorting the underlying stock or investing on margin. Investors in a single-stock ETF do not have to go through a broker approval process to utilize options or set up margin accounts. Moreover, they do not have to pay high interest rates on margin loans and are not subject to margin calls. Some types of accounts (commonly, retirement accounts) cannot engage in short selling or options trading; those investors can express a view or re-weight their portfolios using single stock ETFs.
Other investment management firms are eager to launch their own single-stock ETFs. Direxion and GraniteShares are among several firms that have recently filed with the SEC to launch a swath of single-stock ETFs, aiming to capture an increased share of the over $6 trillion ETF market.
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The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm or its clients, or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
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