Investors are fleeing exchange-traded funds betting against stock index performance in some Asian markets, even as some vehicles generate returns of more than 40% amid the global coronavirus pandemic.
So far this year, international and domestic investors have withdrawn about $2.9 billion in net flows from inverse ETFs across Japan, South Korea and Taiwan, Asia's biggest markets for such products, according to data compiled by Bloomberg. That's about 70% of last year's total inflows.
Using derivatives such as futures and total return swaps, inverse ETFs are designed to move in the opposite direction of their benchmark on a daily basis. The health crisis has dragged down benchmark indexes in the three North Asian jurisdictions by about 20%, thus boosting returns for these instruments. The outflows mean some investors are cashing out, either to book profits or to avoid riskier investments.
The outflows are "common in leveraged products after very large returns," said James Seyffart, an analyst with Bloomberg Intelligence. "We often see outflows in highly volatile or leveraged products because they are risky and investors tend to pull money and take profits when they get them."
Another trigger for the exits may be that "people are simply viewing this as a potential bottom or at least short-term bottom and don't want to hold inverse products," Mr. Seyffart said.
As of Thursday, inverse ETFs run by Nomura Asset Management Co. had endured net outflows so far this year of about $1.7 billion, the most, followed by products from Yuanta Securities Investment Trust Co. and Samsung Asset Management Co.
Even the best-performing vehicles haven't been spared, with Japan-focused funds such as Rakuten ETF-Nikkei 225 Double Inverse Index, Simplex – Nikkei Average Bear Double Exchange Trade Fund and NEXT FUNDS Nikkei 225 Double Inverse Index Exchange Traded Fund seeing redemptions even while generating returns of more than 40%. Currently, inverse ETFs investing in the three markets manage a combined $7.3 billion, Bloomberg data show.
Riskier ETFs were scrutinized as part of the broader passive investment industry during the global financial crisis for their role in market volatility. Furthermore, due to compounding, the returns of inverse ETFs can veer from targets if a fund is held for multiple days without rebalancing. BlackRock Inc., a global leader in ETF products, has argued that leveraged funds should not even be described as ETFs, given their complexity.