Is the Explosion of Single-Stock ETFs an Opportunity or a Danger?

Key Points

• Single-stock ETFs have proliferated rapidly and now number in the hundreds, often providing 2x or 3x leverage on some of the most popular individual companies.
• These funds tend to have high costs and similarly high risks, including the potential for compounding decay if held for longer than a single day.
• Funds focused on NVIDIA, Tesla, and Strategy are among the most highly traded in this space.

The Magnificent 7 account for roughly a third of the entire S&P 500, so it's understandable that some investors might consider focusing an outsized portion of their portfolio on either one of these stocks or a similarly-sized titan of the market. At the same time, single-stock exchange-traded funds (ETFs)—funds that take the common diversification tactic of ETFs and flip it in order to provide leveraged exposure to a single name—have proliferated quickly. There are now hundreds of them available to investors.

The attraction of single-stock ETFs is strong: after all, many of the biggest companies in the world have a long history of outperformance, and these funds can provide double or even triple returns in some cases. However, the risks to these funds are sizable as well. Below are several single-name funds that investors have flocked to, along with a word of caution for those considering this approach.

A Double-Leveraged Play on NVIDIA That Helped Pave the Way

The GraniteShares 2x Long NVDA Daily ETF NASDAQ: NVDL provides leveraged long exposure to shares of NVIDIA Corp. NASDAQ: NVDA. For each day, NVDL aims to generate returns equal to double the percentage change of NVDA stock. The fund has an expense ratio that is quite high compared to most ETFs at 1.05%. While its asset base is only decently sized at under $4 billion, its trading volume tends to be robust—the fund has a one-month average volume of 10.6 million.

Of course, for investors holding NVDL during NVIDIA's major bull run in recent years, the fund was able to amplify already-enormous gains. Indeed, the performance of NVDL during that period may have played an important role in garnering greater interest in single-stock funds overall, as the fund picked up some $2 billion in cumulative inflows in the span of just three years.

However, in the last year, net flows have been about -$2.4 billion, suggesting that retail investors who have been late to buy into NVDL have lost substantial amounts of money or decided to pull their investments, even as NVDA shares are still up about 48% over the past 12 months. The takeaway for investors may be that, for all of its early wins, even a seemingly strong single-stock fund may end up causing damage.

Leveraged Exposure to Tesla Comes With Big Wins But Bigger Risk

For a similar approach focused on Tesla Inc. NASDAQ: TSLA, a popular choice is the Direxion Daily TSLA Bull 2X Shares ETF NASDAQ: TSLL. TSLL is enormously popular, with $4.8 billion in managed assets and a one-month average trading volume of nearly 65 million. Of course, with Tesla's significant volatility in the last year comes even more extreme swings in TSLL shares, which aim to provide double the daily returns on the stock.

While the appeal of TSLA may be strong—and the draw of TSLL potentially even stronger, given its potential to magnify wins and its reasonable expense ratio of 0.83%—the company is subject to a host of risks, including Elon Musk's conflicts, surging competition from Chinese electric vehicle makers, uncertainty surrounding EV incentives, and much more. The result is that TSLA is likely to remain a volatile name for the near-term.

TSLL investors with a high degree of risk tolerance may be able to handle the big swings in Tesla shares, but those looking to just capitalize on a big name, assuming fairly steady wins will continue on a regular basis, may be in for a difficult path.

MSTU: A Leveraged Bitcoin Play With a Painful Track Record

T-Rex 2X Long MSTR Daily Target ETF BATS: MSTU focuses on Strategy Inc. NASDAQ: MSTR, a leading Bitcoin treasury company with one of the largest positions in the cryptocurrency. Even as Bitcoin has declined by about 21% in the last year, there have been days in which MSTR shares climbed. By contrast, MSTU has fallen by over 90% in the past 12 months, an illustration of the risks that investors take if they do not account for a daily leverage reset for this and other leveraged funds.

MSTU's asset base is small at just over $400 million, though it retains strong trading volume with a one-month average of 36.4 million. It has an annual fee of 1.05%, in line with NVDL above.

All of the above ETFs have specific, sophisticated investment strategies implied in their design—investors are meant to utilize them on a short-term basis to capture gains in the underlying stocks over a single day. While this is already difficult to do, the potential for compounding decay and deviation from the performance of the target stock is amplified when investors hold shares of these funds for longer than just a day.

Further, the regulatory status of single-stock ETFs may be in question due to these novel risks, which differ from those of most ETFs.

When investors have a firm reason to believe that shares of a specific company may rise in a single day (say, when they anticipate a positive earnings report or product launch), these funds can be powerful tools to build gains. They may also be useful as hedges over extremely short periods. In many other cases, though, the risks may outweigh the benefits for most retail investors.