South Korea’s $1.7 billion ETF wipeout: What Indian investors should know about leverage bets

Retail investors lost an estimated 2.3 trillion won on leveraged products tied to Samsung Electronics and SK Hynix between May and August. Daily resets can magnify losses over time, especially during volatile markets. 

Retail investors are estimated to have lost 2.3 trillion won ($1.7 billion) from leveraged exchange-traded products tracking South Korea’s two chipmaking giants in just months, according to a lawmaker’s office, in the first revelation of the magnitude of risks from such bets.

Clients of 10 Korean brokerages incurred the losses from single-stock ETFs and notes tied to Samsung Electronics Co. and SK Hynix Inc. between May 27 and Aug. 14, according to the office of Choi Eun-seok, a lawmaker from the opposition People Power Party.

The losses followed a surge in leveraged bets on South Korea’s AI-centric stock market. The wild swings caused by the risky products have since prompted regulators to cool the fervour among mom-and-pop investors, resulting in a plunge in trading volume.

Here's a look at what the leveraged ETFs are, why they are risky and what Indian investors can learn from South Korea's markets

What are leveraged ETFs?

Leveraged ETFs aim to deliver multiples of an underlying stock's or index's daily returns.

"They promise two or three times the daily return of a stock or index. The keyword is daily. The fund resets its exposure every single day, so over a month, it does not give you 2x the return. It gives you 2x of each day's move, compounded. Retail investors buy it as a long-term turbocharged version of the stock. It is a trading instrument with an expiry built into its maths," said Sidharth Sogani Jain, founder, CEO and fund manager at Blue Aster Capital and CREBACO Global.

But, most investors often miss out on the math.

"Take a stock that rises 5% and falls 5% on alternate days for ten trading days. The stock ends down about 1.2%. A 2x ETF ends down about 4.9%, and a 3x ETF ends down nearly 11%. The stock went nowhere, and the 3x fund lost about nine times as much. That is volatility decay. The recovery maths is worse. A fund that falls 82% needs a gain of roughly 456% just to get back to where it started."