(Bloomberg) -- They were all the rage on the way up: high-risk, high-return exchange-traded funds, minted in bulk by Wall Street product managers in the euphoria of the post-election bull market.
Now these speculative products are dealing their owners a gut punch after a series of disappointing economic reports and anxiety over US trade policy have put a brake on risk tolerance across the markets.
From leveraged bets on highly-valued tech companies to esoteric option plays and all manner of cryptocurrency flyers, the selloff that has sent major US stock indexes down for four straight days is being felt the most in fringe ETFs that have been popular among retail traders.
In one stark example, two levered ETFs tied to Michael Saylor’s Bitcoin-hoarding company Strategy, which were together worth more than $5 billion at one point, are down about 40% in three days. Leveraged funds, promising two times the daily performance of Nvidia Corp., Tesla Inc., Amazon.com Inc. have tumbled. Triple-leveraged bets on innovation and semiconductor stocks have slid 20%.
“Momentum can work great when it’s in your favor but when it’s not watch out,” said Max Wasserman, senior portfolio manager at Miramar Capital. “It’s like catching a falling knife.”
Pinpointing the immediate catalyst for the selloff is difficult, but selling pressure rose appreciably on Friday after reports on existing home sales, consumer sentiment and business activity trailed estimates. On Tuesday, the Conference Board said US consumer confidence fell this month by the most since August 2021 on concerns about the outlook for the broader economy, adding to evidence that uncertainty around the Trump administration’s policies is weighing on households.
Exchange-traded products like the ones tied to Nvidia use derivatives to amplify returns or provide inverse performance and have gotten caught in previous market meltdowns. Still, retail investors have flocked to them, drawn in by the promise of big returns. They remain a small but rapidly growing corner of the equity universe, with most of them focused on bullish bets. An analysis by Bloomberg Intelligence showed that earlier this month some $95 billion of assets were housed in products using derivatives to make long bets on single stocks or indexes, while strategies betting on declines had $9 billion.
Even though nothing in the recent behavior of these funds is surprising — they’re designed to give amped-up exposure to the market, whatever it’s doing — their sheer popularity has the potential to increase their impact on sentiment. It’s a risk that has become more pronounced with the growth of crypto and related securities, says Peter Tchir of Academy Securities.
“Greed. The stocks moving the most attracted aggressive investors who wanted leverage,” he said. “The underperformance will be centered on some of the big winners, which is where the fast aggressive money went into single-stock leveraged ETFs.”
It’s not just leveraged trades that are getting punished — simple bets on technology companies and other would-be innovators have also suffered. A gauge of the “Magnificent Seven” megacaps sank as much as 3.4% on Tuesday.
Cathie Wood’s $6.2 billion ARK Innovation ETF (ticker ARKK), a favorite among retail traders, dropped as much as 6.7% Tuesday. Downturns in a slew of speculative tech companies have dragged the fund lower, led by Elon Musk’s Tesla, its biggest holding, Roku Inc. and Palantir Technologies Inc. Her flagship ETF is on track for a 14th consecutive month of outflows, dragging assets under management across her active ETF lineup down to around $12 billion, a far cry from the $60 billion they held four years ago.
“There’s no question that the animal spirits in the marketplace are receding. It began last week with the declines in stocks like Palantir Tesla, and Meta,” said Matt Maley, chief market strategist at Miller Tabak + Co. “Now we’re seeing it with the outsized drops in Bitcoin.”
