The latest innovation in the ETF space has caught the watchful eye of Massachusetts Secretary of the Commonwealth William Galvin, whose office announced a “sweep of single stock ETF offerings” Thursday.
With the first single-stock ETFs only about a month old and the pipeline for new offerings suggesting dozens more will be receiving approval from the Securities and Exchange Commission, Galvin’s office is seeking to protect “Main Street investors” from harm by initiating a “sweep of complex single stock exchange traded fund offerings recently made public and offered through Massachusetts registered broker-dealers.”
“These are risky products, investing in only one stock, with no diversity cushion whatsoever,” Galvin said in a prepared statement.
“For nearly all Main Street investors, there is no difference between investing your money in single-stock ETFs and gambling with that money at a casino,” he added. “Under no circumstances should an investor use these products as a long-term investment.”
Galvin isn’t the first to wave the caution flag on these newfangled ETFs, which employ options to offer levered and inverse exposure to a single stock. In mid-July, as the SEC was allowing the first single-stock ETFs to hit the market, SEC Commissioner Caroline Crenshaw published a memo warning of the potential harm to investors who might not understand the nuances of ETFs designed for active traders.
“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 wrote. “However, retail investors can and do access leveraged and inverse exchange-traded products through 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.”
Nate Geraci, president of The ETF Store, said the single-stock ETFs represent a “double-edged sword and has created some real challenges for regulators.”
By design, the new ETFs enable traders to capture specific exposure to a company or tweak the exposure to a broader index by amplifying exposure or betting against a single company.
The biggest risk would be holding these kinds of ETFs for more than one day.
“We know with certainty that these products will end up in the hands of retail investors who may not fully appreciate or understand the meaningful risks involved,” Geraci said. “The question is where should the responsibility lie? Should these products be regulated into oblivion, or should the onus be on investors to do their homework as long as ETF issuers have provided proper disclosures? That seems to be what various regulators are grappling with right now.”
Todd Rosenbluth, head of research at VettaFi, agreed that the Galvin announcement “is consistent with the fact that while these ETFs came to market members of the SEC raised concerns and cited the risks for end investors with words of caution for their advisers.”
“These products are not appropriate for use as a long-term investment,” Rosenbluth said.
Galvin’s office sent inquiry letters Thursday to Foreside Fund Services, IMST Distributors, ALPS Distributors and Quasar Distributors. The entities receiving the inquiry letters are registered broker-dealers in the Commonwealth which distribute the Direxion, AXS Investments, GraniteShares and F/m Investments product lines, respectively.
Greg Bassuk, chief executive of AXS Investments, said the levered and inverse strategies being employed by the single-stock ETFs has been used by sector and industry ETFs in the U.S. for at least a decade.
AXS became the first company to launch a single-stock ETF when it rolled out eight funds on July 14, including AXS TSLA Bear Daily ETF (TSLQ), which offers short exposure to Tesla stock.
“I go back to the notion that there’s nothing new about what we’re doing,” Bassuk said. “The way these products work is exactly the way they’ve worked for over a decade for traders with a high-conviction view. They’re time-tested.”
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