After a volatile few months in global markets, leveraged exchange-traded funds (ETFs) are losing their appeal in both the United States and South Korea. These funds, which use borrowed money to amplify daily stock moves, have been popular among investors chasing big gains in AI-linked stocks. But the recent turbulence has reminded everyone that leverage cuts both ways.
What are leveraged ETFs?
A leveraged single-stock ETF is designed to multiply the daily percentage move of an underlying company's shares. For example, if a stock rises 1% in a day, a 2x leveraged ETF aims to rise 2%. If the stock falls 1%, the fund drops 2%. The effect is achieved by borrowing money or using derivatives to increase exposure.
These funds are not meant for long-term holding. Because they reset daily, their returns can diverge significantly from the underlying stock over longer periods, especially in choppy markets. That's a key reason why they're often described as trading tools rather than investments.
Why the popularity boom?
In recent years, leveraged ETFs have taken off in both the US and South Korea, largely driven by retail investors eager to ride the AI rally. The money parked in US leveraged ETFs reached a record $218 billion in June, according to the brief. In South Korea, similar products have also attracted substantial inflows, as local investors sought exposure to tech giants like Nvidia and other AI beneficiaries.
The appeal is obvious: who wouldn't want double the gains? But the flip side is that losses are also doubled, and in a market downturn, that can be painful. The recent volatility—sparked by concerns about trade wars, interest rates, and geopolitical tensions—has made that risk painfully real.
What changed?
Over the past few months, markets have swung sharply. For instance, US trade policy has been unpredictable, and geopolitical tensions have rattled investors. These factors have led to sudden drops in tech stocks, which are heavily weighted in leveraged ETFs. Investors who bought these funds near the top have seen their holdings fall much faster than the underlying stocks.
In South Korea, the won's strength and chip export data have been bright spots, but the tech-heavy market has still felt the sting of global sell-offs. The result is that many investors are now questioning whether the potential for double gains is worth the risk of double losses.
What it means for investors
For everyday investors, the lesson is straightforward: leveraged ETFs are not for the faint of heart. They are designed for short-term trading, not for building long-term wealth. If you hold them through a downturn, your losses can be magnified, and the daily reset can erode your returns even if the underlying stock eventually recovers.
Regulators in both the US and South Korea have issued warnings about these products, and some have even restricted their sale to retail investors. The recent decline in popularity suggests that many investors are heeding those warnings.
If you're considering a leveraged ETF, it's crucial to understand the mechanics and the risks. They can be a useful tool for experienced traders who are comfortable with high volatility and who monitor their positions daily. But for most people, a plain, unleveraged ETF that tracks a broad index is a safer way to participate in market gains.
Looking ahead
The future of leveraged ETFs is uncertain. If market volatility continues, their appeal may keep fading. But if the AI rally resumes and markets calm down, some investors may be tempted back. For now, the takeaway is clear: leverage is a double-edged sword, and the recent months have shown just how sharp the downside can be.
As always, it's wise to do your own research and consider your risk tolerance before diving into any investment product. And remember, there's no such thing as a free lunch—especially when it comes to leveraged ETFs.
