UK-based sponsor of physically backed exchange-traded products (ETPs) Leverage Shares entered the market in early June with a focus on US stocks.

SRP spoke to Oktay Kavrak (pictured), CFA – Institutional sales at the UK firm about the key elements of leverage ETPs and how to avoid the pitfalls uncovered by the spike in market volatility earlier this year.

Leveraged ETPs are very popular in markets such as Germany, Singapore and Hong Kong but not so much in the UK. What are the reasons for this lack of adoption among UK investors?

Oktay Kavrak: These products are very popular in markets where self-directed investors seem to be into trading very risk-on products such as certificates and warrants. It could be a cultural thing - UK investors seem focused on investing for the long term - they have some passive investments that grow over time, and don’t want to speculate that much. Investors in countries like Italy and Germany are more aggressive including professional day-traders. A study done on trading in more speculative products in Asia attributed their popularity to pillars like sound legal frameworks and transparency – so these factors definitely play a role.

Half of people that invest in products listed on the LSE are located outside the UK

One of the appeals of listing on the London Stock Exchange [LSE] is that we have access to investors from all over the globe. About half of people that invest in products listed on the LSE are located outside the UK. That’s why we chose LSE, to make our products available in multiple currencies so investors, whether they are in the US, Europe or Asia, can access these products instead of trying to trade in alternatives like options, futures, CfDs and other risky instruments. That said, given both increasing demand and to allow for better access across continental Europe, we are planning a cross-listing of all our products on Euronext by the end of July.

What are the key elements of leverage ETPs? Are investors aware of the risks?

Oktay Kavrak: The market maker is very important, just as the leverage factor is. It is also really important for the actual investor to understand the concept of what daily compounding means. How it translates to returns over longer periods that are more than one day and may not equate to what they expect. 

Our products offer anywhere from inverse -1x to 3x exposure, but if you buy one of our ETPs on Amazon, let’s say the 2x, and you see that the underlying has increased by 10% over two weeks, you might automatically think that the product is up 20%. However, the leverage factor, the volatility of the underlying, and how long the investor holds the product has a significant impact on the profitability of the ETP - it can actually do better than what investors expect but it can also do worse. Momentum is key.

This is one of the mistakes South Korean providers struggled with. It is really important to make sure there is not a certain level of volatility because if you have a product that is going to be delisted in a couple of months because it is going the opposite direction of what the underlying is doing, that is a very dangerous thing to do. We saw some leveraged ETPs that followed oil which were delisted within a matter of days once the underlyings went into negative territory. 

Are Leverage Shares ETPs different to other leveraged listed products?

Oktay Kavrak: Unlike other leveraged/inverse ETPs, we don’t use derivatives through banks to gain our leveraged exposure. Each one of our ETPs is physically backed by purchasing the underlying stocks directly and protects investors from counterparty risk.

Anytime you trade these types of products, you really should know what you are trading. The same thing would happen if you are trading in futures which are on margin, which is even more dangerous, because fees and costs add up and you could lose even more than what you put in.

The biggest benefit of our products is the zero - the actual bottom. Investors cannot fall below that. Our products also have a built-in airbag mechanism in case there are huge deviations - If the underlying moves more than 20%, investors are cushioned because the product would then be re-levered to match the leverage factor. They then resume trading as if it were a new trading day.

For example, if you have a 3x product and the underlying drops by 33%, the product does not have to be delisted in one day. You have these safety built-in features that makes them a much safer proposition than other leveraged products.

What is the USP of leveraged/short ETPs?

Oktay Kavrak: These products are very easy to access and can be used to take advantage of new ideas and market moves very quickly. They trade like any other stock or ETF and can be traded via a share dealing or brokerage account. 

They are meant for sophisticated investors but anyone with a brokerage account can use these products. A lot of people want to trade with leverage, they want to take bigger strategic positions on certain stocks. Opening futures accounts and trading on margin is not something you can do overnight - there is complexity involved. Investors sometimes throw themselves into these products without doing due diligence and this cannot be taken lightly - we saw the news recently about a US college student who was involved in options trading and, unaware of the inner workings, ended up committing suicide as his account was over US$700,000 in the red.

With our products, losses are capped, there are no hidden fees like holding fees, and investors don’t have to pay stamp duty which is big in the UK. It is a very simple product that offers sophisticated techniques - that is the selling point, we are providing convenience. 

Do leverage ETPs fit within a portfolio construction approach? 

Oktay Kavrak: Yes. That is one of the reasons why the mutual fund industry is dying out. ETFs have proven that you can buy an index-based ETF, hold on to it for the long term, and actually outperform mutual funds after accounting for performance and management fees. More and more issuers are trying to make products that can be used not only for daily holdings but could also be a fit for the longer term in a portfolio.

As an example, all the FAANG underlyings [Facebook, Apple, Amazon, Netflix, Google, Alphabet] hit rock-bottom on 23 March but since then they have increased by an average of 43.2% as of 10 June. Over the same time span, their Leverage Shares 2x ETP counterparts returned 98.8%. Even if you go year-to-date, some of them, like the 2x Amazon ETP, still outperformed their underlying stocks even given the huge level of volatility we saw in March. 

One of the main developments of financial engineering over the last couple of years is the shift from pushing products to the market with a one-size fits all approach to creating products that are both in demand and work to the benefit of clients. And this is a win-win for all.

What is Leverage Shares’ short-term goal?

Oktay Kavrak: The main thing for us right now is getting the word out. Trying to educate investors and traders that these types of products exist and can be accessed in the UK too. It is not something that the general public has heard of - even many experienced investors, who have been trading options and futures their whole lives, don’t know about the specifics of these ETPs.

We are not using huge leverage factors, so that could make them more suitable for holding periods of more than a day. Investors can use them to hedge their position and they can also be used for a variety of strategies, just like normal stocks could be. 

We want to help our clients understand that there is a wide array of strategies for which they can be used. It is not just taking leveraged positions on a single stock, which some people would consider as making a huge gamble. The leverage factor and the stocks on which they are offered are specifically chosen for them to be able to be implemented in the context of a strategic portfolio.