Long-term U.S. ETFs gain traction among Korean retail investors

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South Korean retail investors are increasingly engaged in betting on long-term offshore leveraged exchange-traded funds (ETF) amid growing expectations that the U.S. Federal Reserve’s interest rate hike cycle has neared an end.

According to data from the Korea Securities Depository on Wednesday, retail investors in Korea net purchased $244.9 million worth of the Direxion Daily 20+ Year Treasury Bull (TMF) ETFs between Jan. 2 and April 4, the largest amount during the period.

The TMF ETF is a leveraged product that seeks a daily investment yield of 300 percent in U.S. long-term bonds with a maturity of 20 years or longer.

Retail investors also net purchased $82.71 million in the iShares 20+ Year Treasury Bond (TLT) ETFs, which track the investment results of U.S. Treasury bonds with remaining maturities greater than 20 years during the period. It ranked the 10th largest investment by net purchases.

Long-duration bonds have a high price volatility depending on interest rates as compared to short-term bonds. The U.S. 10-year Treasury bond yield, which rose to 4.4 percent at the end of last year following the collapse of the U.S. Silicon Valley Bank (SVB) that set an alarm for an economic recession and expectations that the Fed‘s rate hike would end shortly, fell to a low of 3.35 percent on Tuesday, local time.

The yield on longer, 30-year U.S. Treasury bonds rose to as high as 4.5 percent at the end of last year before declining to 3.6 percent. As bond prices and interest rates move in opposite directions, bond ETF prices went up during the same period.

The price of the TLT ETFs rose by 16 percent from the low in October last year, and the 3X leveraged TMF ETFs by 48 percent. The annual yield of the TMF ETFs this year is also 13.95 percent. Bond prices generally do not fluctuate as much as listed stocks, but the rise was particularly big for the 3X leveraged product given its leverage ratio.

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Investors are flocking to bond ETFs in anticipation that long-term bond prices will rise further if the Fed cuts interest rates or an economic recession actually sets in.

Yet, the higher the leverage ratio, the greater the loss when stock or bond prices remain stagnant. If you invest 1 million won ($759.3) in a bond ETF, for example, the net asset value becomes 990,000 won if the stock price rises 10 percent but later falls 10 percent. However, if the leverage ratio is 3 times, a 10 percent increase in prices results in a yield of 300,000 won while a 10 percent decline will result in a loss of 910,000 won, which is bigger than that of the non-leveraged ETFs.

“The problem of leveraged ETFs is that they have no safeguard against a decline,” said Cho Joon-ki, an analyst at SK Securities Co. “The return can be very low despite the high risk if you don’t seize the right timing even if they are headed upward.”

Retail investors also net bought a large number of other 3X leveraged products this year.

The second most purchased product was the ProShares UltraPro Short QQQ (SQQQ) ETF, which tracks three times the inverse of the daily return of the U.S. Nasdaq 100 Index with a net purchase of $199.64 million. They also bought $162.91 million worth of Direxion Daily Semiconductor Bear 3X Shares (SOXS) ETFs, which inversely track the daily return of the U.S. PHLX Semiconductor Sector Index (SOX).

However, these inverse ETFs have delivered a very low yield as all major indices in the U.S. went up this year. The annual return of the SQQQ and SOXS ETFs are minus 45.84 percent and 56.71 percent, respectively.

The third and fourth most popular items by net purchases among the retail investors this year were Microsoft Corp. and Tesla Inc. with a purchase of $195.37 million and $179.97 million each.