This article first appeared in Personal Wealth, The Edge Malaysia Weekly on June 22, 2020 - June 28, 2020

Leveraged and inverse exchange-traded funds (L&I ETFs), which allow sophisticated investors to amplify their returns during market volatility, are slowly gaining traction more than six months after they were launched on the local bourse last year. These ETF products were created to produce targeted, multiple returns of the underlying index on a daily basis.

According to Bloomberg, the monthly average trading volume of the six locally listed L&I ETFs stood at about 2.07 million units over the past seven months, which is very low when compared with those of other stocks on the local exchange. For instance, Malayan Banking Bhd, a blue-chip stock and component of the FBM KLCI, had a 30-day average trading volume of 7.17 million as at June 16.

Nevertheless, these L&I ETFs have been making some headway in the local ETF space. In January, 5.57 million units were traded on Bursa Malaysia, representing about 59% of the total trading volume of the ETF industry. Last December, only 1.9 million units were traded, representing 48% of the industry’s total trading volume. 

Yet, the trading of the L&I ETFs has been quite volatile. Last month, only 393,700 units changed hands, representing just 8% of the industry’s total trading volume. But in April, 1.04 million units, or 15% of the industry’s total volume, were traded. 

The six L&I ETFs on the local bourse are the Kenanga KLCI Daily 2x Leveraged ETF, Kenanga KLCI Daily (-1x) Inverse ETF, TradePlus HSCEI Daily (2x) Leveraged Tracker, TradePlus HSCEI Daily (-1x) Inverse Tracker, TradePlus NYSE FANG+ Daily (2x) Leveraged Tracker and TradePlus NYSE FANG+ Daily (-1x) Inverse Tracker.

These ETFs are accessible to sophisticated investors who have a margin account or have executed at least five transactions of exchange-traded derivatives or structured warrants in the preceding 12 months. Investors who are interested in trading these instruments, but fail to meet the necessary requirements, can undergo an e-learning tutorial developed by Bursa, which is available online. 

Chong Lee Choo, director of Innovation Lab and alternative investment at Affin Hwang Asset Management Bhd (AHAM), says L&I ETFs under the TradePlus brand are traded by local fund managers and retail investors. 

Kenanga Investors Bhd CEO Ismitz Matthew De Alwis says its two L&I ETFs are mainly traded by retail investors. “We believe that the initial investors are most likely to be retail players. But over the time, we expect institutional investors to access these ETFs once their internal mandates allow them to trade L&I ETFs.” 

The low trading volumes of these ETFs are due to a lack of awareness among investors, says Chong. “We foresee that it will take time for us to create awareness among investors and educate them on how these instruments work.”

De Alwis agrees. “Subscriptions [to our products] have been sporadic over the last three months. Many investors do not have the awareness of how to utilise these ETFs to enhance their portfolios or the skill set to access these products,” he says. 

The process investors are required to go through to trade L&I ETFs is another hurdle. “Investors need to go through a process that would qualify them to trade these ETFs. At this juncture, the number of qualified investors is rather small,” says Chong.

Demand could pick up

Chong believes there is an existing demand for L&I ETFs. She bases her assumption on how the trading of structured warrants tends to pick up when markets are volatile.

Structured warrants are proprietary instruments issued by third parties such as brokerage firms or financial institutions. They give holders the right, but not the obligation, to buy or sell the underlying assets some time in the future at a fixed price. Like L&I ETFs, structured warrants allow investors and traders to long or short a particular stock or index using leverage. 

“We have observed that structured warrants see a lot of trading. In fact, the sale of certain structured warrants had to be halted as the units in circulation were fully taken up,” says Chong. 

“We believe that L&I ETFs, like structured warrants, are attractive to investors with a higher risk appetite, especially when markets are volatile and there are larger swings.”

She adds that L&I ETFs are more convenient than structured warrants as investors would need to regularly monitor the price and expiry date of their warrants. “Warrants could expire and be worthless, which means investors may lose their entire investment. This creates an urgency for investors to regularly monitor their holdings.”

L&I ETFs, on the other hand, do not have an expiry date. “The fund manager of such ETFs would monitor the expiry dates [of the underlying futures contracts] for the investors. The fund manager would then roll these contracts over (carry forward the contracts’ position to another expiry date) before they expire,” says Chong. 

“So, these ETFs do not have an expiry date [although they have some similar features to structured warrants]. Investors would be able to monitor their returns without the hassle of constantly monitoring the expiry dates.”

Future developments 

There could be some new developments that would contribute to a higher trading volume of L&I ETFs, says Chong. For instance, the regulators could make it easier for investors to qualify for the trading of these ETFs. 

“There aren’t any details yet on how we can assist investors in making the process more convenient, but rest assured it is being looked into by the relevant parties, including industry players and regulators. We believe these instruments will be easier to trade in the future,” she says, adding that the most important thing now is to educate investors on the risks of trading these instruments. 

More fund managers of private mandates and unit trust funds could be allowed to utilise L&I ETFs as part of their investment strategy, which could help them better manage their portfolios. De Alwis says these instruments would allow fund managers to express a specific investment view and provide them with a broader range of options to manage their portfolios better. 

“For now, it depends on their mandates, whether a local fund manager can trade these instruments or not. Not many private mandates and unit trust funds are reviewing this as a permissible instrument. Many firms have not obtained the necessary approvals yet,” he adds. 

Chong agrees, saying that L&I ETFs could be more popular among fund managers in the future. More funds with various strategies could also be launched. 

“We do not discount the possibility of this happening in the future. In the interim, however, the unit trust industry will remain tilted towards more conventional, long-only strategies to cater for the retail market,” she says. 

“Meanwhile, L&I ETFs will come into play as a defensive strategy, which comes in handy during a more volatile environment, when fund managers are looking for hedging solutions.” 

Chong says AHAM has no immediate plans to introduce more L&I ETFs. “But we will continue to monitor the demand for such products and launch more of them at the right time.” 

De Alwis expects more of such products to be launched over the long term as well. “Judging from how these ETFs have grown in the developed markets, I am confident that we will see more products being introduced over the long term,” he says. 

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