Coming soon: Single-stock ETFs for traders but not investors

The first examples of this new strain of ETF creativity could hit the markets within days, giving day traders another toy and financial advisers another headache.

Just when you think the ETF space has pushed beyond the limits of rational innovation, along comes a plan to launch exchange-traded funds offering exposure to a single stock.

As bizarre as it sounds, single-stocks ETFs will likely appeal to select investing subcultures, including savvy financial advisers applying creative portfolio management strategies and just about anyone with a Robinhood account.

According to Eric Balchunas, fund analyst at Bloomberg Intelligence, there are currently about 80 such ETF filings from four asset managers awaiting approval from the Securities and Exchange Commission.

A “post-effective” announcement from the SEC earlier this week for at least one of the ETF filings from AXS Investments suggests we could see the first single-stock ETF within days.

Balchunas said the new ETFs offer leveraged and short-selling exposure to specific companies without requiring the hoop-jumping challenges of derivatives and options.

“The big secret of ETFs is making things easy,” he said.

“Imagine, for instance, you own the S&P 500 Index and [Tesla Inc. CEO] Elon Musk goes crazy,” Balchunas said. “You can add an inverse Tesla ETF in proportion to Tesla in the index to neutralize your exposure to that one company.”

While single-stock ETFs are new to the U.S. market and are coming with a warning label from the SEC, there’s some precedent in Europe, where about $2.5 billion is invested in similar strategies.

“It’s pretty small in Europe, but the U.S. market is a much bigger place, and we like gambling here,” Balchunas said. “My guess is there’s going to be a couple big hits, but we will see a lot of spaghetti thrown against the wall and a lot of the ETFs will close.”

While the SEC under Chairman Gary Gensler’s aggressive agenda is expected to let single-stock ETFs reach all the way to the great unwashed retail investor market, there has been resistance from within the commission.

Earlier this week, once it became apparent the first single-stock ETFs were moving toward the starting gate, SEC Commissioner Caroline Crenshaw issued a statement suggesting the new ETFs amplify her existing concerns over leveraged and inverse funds.

“I worry that these single-stock ETFs pose yet another, perhaps greater, risk for investors and the markets,” she wrote.

Among Crenshaw’s concerns is the way the leveraged and inverse ETFs rebalance daily, which could cause extreme performance volatility if held over multiple days.

It’s estimated that single-stock ETFs will experience volatility levels at least five times that of the S&P 500.

“I found Crenshaw’s statement eye-opening in that she indicated investment professionals recommending these products would likely be breaching their fiduciary obligation to clients,” said Nate Geraci, president of The ETF Store.

“However, the SEC is obviously approving these products for use by novice retail investors,” he added. “That seems highly contradictory.”

Todd Rosenbluth, head of research at VettaFi, agreed that the single-stock ETFs should be viewed as trading vehicles rather than something to buy and hold.

“While ETFs are known for diversification benefits, these pending single-stock leverage and inverse ETFs will provide end investors with ease of use and liquidity to provide short-term tactical exposure to high-profile and volatile stocks,” Rosenbluth said. “However, advisers and investors need to be aware that the risks can become significant the longer leveraged and inverse ETFs are held.”

For the ETF space, the appeal is clear. The companies can charge higher fees and, as Balchunas points out, they are shielded from the fee wars, “because you’re never going to see Vanguard come out with a single-stock ETF.”

But even though the “genie is out of the bottle,” Balchunas remains flummoxed as to why Gensler would give the nod to single-stock ETFs but still have a problem with a fund offering direct exposure to bitcoin.

“A spot bitcoin ETF would be a lot safer,” he said. “It seems like Gensler doesn’t care how dangerous they are as long as the process is legal and regulated.”

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