Inverse ETF investors face losses on dollar rebound

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As the value of the U.S. dollar continues to surge at a rapid pace, South Korean individual investors who have bet against the dollar face mounting losses. The recent appreciation of the dollar has caught many off guard as concerns over China’s economic slowdown and positive economic indicators in the U.S. have defied expectations, leading to unexpected outcomes. Additionally, retail investors who increased exposure to the yen in hopes of a rebound are now believed to be struggling with sustained yen weakness.

According to the Korea Exchange on Sunday, individual investors purchased a net total of 41.8 billion won ($31.2 million) worth of the ‘KODEX U.S. Dollar Futures Inverse 2X’ exchange-traded fund (ETF) up for the first 17 days of this month. This stands as the largest net purchase among ETFs, excluding equity-based ETFs. The dollar inverse ETF seeks to double the percentage decline in the Korea Exchange’s Dollar Futures Index. This reflects the high number of retail investors who anticipated a weakening dollar this month.

Conversely, individual investors sold a net total of 2.5 billion won worth of the ‘KODEX U.S. Dollar Futures Leverage’ ETF, which bets on a strengthening dollar, during the same period.

However, with the ongoing dollar strength, investors are likely to face losses. The value of the dollar against the Korean won recently approached the 1,340 won mark, threatening the year’s lowest point of 1,343 won. As a result, the ‘KODEX U.S. Dollar Futures Inverse 2X’ ETF dropped by 10.11 percent during the same period, while the ‘KODEX U.S. Dollar Futures Leverage’ ETF gained by 11.32 percent, surpassing its previous high.

Additionally, even for ETFs investing in the same assets, returns differed based on their currency exposure. Currency-exposed ETFs managed to maintain profitability, benefiting from the strength of the dollar despite the decline in U.S. stock market indices.

The background to the dollar’s continued strength lies in the divergent economic situations of China and the U.S. As China’s economic indicators remain sluggish and concerns over defaults in real estate development companies grow, the Korean won declined due to its high dependence on the Chinese economy.

Furthermore, the U.S. Federal Reserve’s hawkish policies aimed at tackling inflation, as revealed in the minutes of the Federal Open Market Committee (FOMC) meeting on July 16 (local time), caused bond yields to surge and further fueled the strength of the dollar. This points out that the judgments of investors in the dollar inverse ETF, who anticipated a more relaxed Fed policy, have gone awry.

Experts project that exchange rate market volatility will likely expand for the time being. “If the U.S. economy remains robust, inflation will not be easily controlled, and the strong dollar trend resulting from prolonged tightening may continue,” said Kim Seung-hyuk, an analyst at NH Futures. “There is also a growing sense of consensus that the recent dollar strength has gone too far.”

This year, investors focusing on the yen have been steadily increasing, as the value of the yen reached its lowest level since 2015. According to Mirae Asset Global Investments, the ‘TIGER Yen Futures’ ETF, which enables investment in the yen, saw individual net purchases of 77.4 billion won in the first half of the year, five times higher than the previous year’s 15.7 billion won. Notably, during June and July, individual net purchases came to 73 billion won.