Leveraged ETF Trading Surge Means Japan Stocks Calm May Not Last

21 Apr 2020, 08:16 AM IST

(Bloomberg) -- Japan stocks have regained some calm after the coronavirus wreaked havoc on global markets, but strategists are warning that the increased trading of speculative exchange-traded funds could mean more tumult ahead.

On Friday and Monday, two of the top three securities that changed hands the most by value were leveraged ETFs betting on the Nikkei 225 Stock Average’s moves. By nature, those vehicles use derivatives to amplify the return of the underlying securities, causing larger price swings when positions are added or reduced.

“It’s a market where speculative trading is rampant, with investors trying to make profit off a daily drop or rise in stock prices,” said Norihiro Fujito, the chief investment strategist at Mitsubishi UFJ Morgan Stanley Securities Co. “Long-term investors like pension funds and investment trusts are on the sidelines” given how badly the virus will hit the economy and corporate profits for the June quarter, he added.

Leveraged ETF Trading Surge Means Japan Stocks Calm May Not Last

Nomura Holdings Inc.’s Next Funds Nikkei 225 Leveraged Index ETF, which doubles the return of the index, and its Next Funds Nikkei 225 Double Inverse Index ETF, which gives owners twice the opposite return of the blue-chip gauge, were Japan’s most-traded securities after SoftBank Group Corp. on Friday and Monday, according to SBI Securities Co. data. On Monday, more than 148 billion yen ($1.4 billion) and 57 billion yen in the funds changed hands, respectively, compared with 265 billion yen for SoftBank, the figures show.

“It’s a position-driven market,” said Shusuke Yamada, a strategist at Bank of America, adding that the unwinding of short bets was behind the recent market rebound. “But we have companies unable to make forecasts for their earnings. High volatility will continue.”

Almost 10 million shares of Nomura’s leveraged fund traded on Monday, compared with about 7.7 million daily average in the past year, data compiled by Bloomberg show. For the inverse ETF, 53 million shares changed hands, versus a mean of 39 million. Volume was even higher on Friday.

“Hedge funds and day traders often like these vehicles,” said John Vail, the chief global strategist of Nikko Asset Management Co. “Leveraged short ETFs investors are getting squeezed by the rally.”