Market observers have been wary about how leveraged and inverse exchange traded funds impact the financial markets as they rebalance portfolios, but the concerns may be largely overblown.
“There is a false narrative about leveraged and inverse ETFs being spread by the prudential regulators,” Mike Piwowar, a member of the Securities and Exchange Commission, said at a Investment Company Institute conference, Reuters reports.
Leveraged and inverse ETFs utilize derivatives contracts to enhance daily index returns. For instance, most leveraged ETFs are designed to produce double or triple the performance of the underlying market on a daily basis while inverse options reflect the opposite moves to a benchmark. [Do You Know How Your Leveraged ETFs Work?]
Some are concerned that these products have raised the stress in the financial market, fueling volatility and wild swings in stocks. However, these concerns may be wild conjectures.
“It is the unsubstantiated assertion that these products contribute to increased volatility in the financial markets because they must rebalance their portfolios in the same direction as the contemporaneous return on the underlying assets in order to maintain a constant leverage ratio,” Piwowar said.
Leveraged ETFs typically track large and liquid indices. Consequently, any liquidity needs are quickly met in the same way other index-based ETFs rebalance throughout the year, except leveraged/inverse ETFs rebalance on daily basis.
Additionally, leveraged/inverse ETFs only make up a small portion of the ETF space, which makes it less likely that such a small area could affect the overall financial market. Leveraged/inverse ETFs have about $41.0 billion in assets under management, whereas the total U.S.-listed ETF space has over $2.0 trillion in assets, according to XTF data.
The SEC’s chief economist, Mark Flannery, has stated that his staff was working on a new white paper to study whether or not ETFs “exacerbate financial volatility.” Nevertheless, Piwowar has said that the Federal Reserve’s own economists recently found claims about ETFs and volatility to be “likely exaggerated” and “overblown.”
For more information on ETFs, visit our ETF 101 category.
Max Chen contributed to this article.