The U.S. securities market regulator has paused the review of proposals for new highly leveraged exchange-traded funds from several fund managers and sought more clarity on the risks tied to the products.
In its warning letters sent to nine ETF providers including Direxion, ProShares and GraniteShares on Tuesday, the Securities and Exchange Commission said some funds have sought to track as much as fives times the performance of the underlying stock.
“We write to express concern regarding the registration of exchange-traded funds that seek to provide more than 200 per cent (2x) leveraged exposure to underlying indices or securities,” the regulator said.
Tidal Financial, one of the nine recipients, declined to comment, while the others did not immediately respond to requests for comment.
Leveraged ETFs, often favored by retail investors, have exploded in popularity lately due to sustained bullish market sentiment, the rise of speculative trading and a surge in product innovation, especially around single stocks and cryptocurrencies.
The regulator said its concerns stem from Rule 18f-4 under the Investment Company Act of 1940, which requires a fund’s value-at-risk to remain below 200 per cent of the value of an appropriate reference portfolio.
The SEC asked fund managers how they determine the reference portfolio used to measure leverage risks and suggested the issuers to revise their strategies to comply or withdraw filings.
The latest scrutiny adds pressure to the growing leveraged ETF market, which continues to attract retail investors despite regulatory concerns over their complexity and risks.
The largest leveraged ETF, US$31.3-billion ProShares UltraPro QQQ ETF (TQQQ-Q), which targets three times the daily performance of the Nasdaq 100 index, has gained close to 40 per cent so far this year.
However, the outsized returns come with higher risks.
Among the hardest hit this year is one tied to Strategy shares, according to VettaFi’s ETF database.
The Defiance Daily Target 2x Long MSTR ETF (MSTX-Q) has plunged more than 83 per cent this year. An ETF tracking twice the performance of Super Micro has dropped more than 60 per cent, while the 2x long cannabis ETF is down 59.4 per cent.