Investors should be aware of the 'gambling mindset' that single-stock ETFs tap into, says an expert.

• The success of single-stock ETFs, which are leveraged, is not surprising given the rise of big-tech stocks.
• According to Bryan Armour, director of passive strategies research for North America at Morningstar, the investing approach appears to be a long-term trend.
• Not all single-stock ETFs have achieved success, as seen with the closure of ETFs tracking Nike and Pfizer.

Despite the passage of more than a year since the introduction of single-stock exchange-traded funds in the U.S., risk-taking investors remain drawn to them.

In Europe, single-stock ETFs were first introduced in 2018. Currently, there are almost 40 single-stock ETFs in the US, many of which track the "Magnificent Seven" stocks - , , , , , and . Additionally, Morningstar's list of single-stock ETFs includes names such as and .

According to Morningstar, single-stock ETFs have a total net asset value of approximately $3.3 billion.

The rise of single-stock ETFs, which are leveraged, is not unexpected given the market's 40% increase this year and the surge in big-tech stocks. However, they may have a permanent place in the market.

Morningstar's director of passive strategies research for North America, Bryan Armour, stated that single-stock ETFs will remain a popular investment option. He explained that this strategy appeals to the gambling mindset that exists in financial markets.

The single-stock ETF market is growing and its future direction is something investors should be aware of.

Where the single-stock ETF action is, starting with Tesla

According to Morningstar, there are 45 single-stock ETFs in total, from providers such as Direxion, AXS, GraniteShares, and YieldMax. These ETFs employ bull, bear, or option income strategies.

The largest ETF in the U.S. by asset size is the Direxion Daily TSLA Bull 1.5X Shares, which tracks the Tesla stock index. In July, it surpassed the $1 billion asset mark, making history.

The YieldMax TSLA Option Income Strategy ETF is the second-largest single-stock ETF by asset size, with approximately $841 million in assets at the end of November, according to Morningstar.

The GraniteShares 1.5x Long NVDA Daily ETF, which tracks Nvidia and has surged in a year marked by AI optimism and chipmakers' gains, is in third place by asset size with approximately $245 million in assets at the end of November, according to Morningstar data.

Leveraged and inverse ETPs may employ a variety of investment strategies to achieve their desired returns, such as swaps, futures, and derivatives, as well as long or short positions, as per a FINRA explainer.

Expect more high-risk ETFs to hit the market

Robert W. Baird & Co.'s head of program and ETF trading, Rich Lee, anticipates an increase in single-stock ETFs with an options overlay strategy and income component. YieldMax provides several such ETFs that aim to generate monthly income through selling/writing call options on single-company stock exposures.

Single-stock ETFs provide quick exposure with leverage, and there will continue to be innovation in combining themes and exposures under the ETF wrapper, according to Lee.

Despite the growth in the number and assets of ETFs, there have been disappointing results. Some single-stock ETFs, such as those tracking Nike and Armour, have underperformed this year. Investment managers must decide where to allocate their resources if an ETF fails to gain traction. It's essential for investors to remember that what's available today may not be the same in the future.

Using single-stock ETFs is not a long-term strategy

The performance of certain ETFs tracking cryptocurrencies fluctuates greatly. For example, the Direxion Daily TSLA Bull 1.5X had a one-year return of approximately 12% through November but experienced a year-to-date return of about 148% through December 15, according to Morningstar. Similarly, the GraniteShares 1.5x Long COIN Daily ETF, which tracks Coinbase, had a one-year return through November of approximately 206% and returned about 488% year to date through December 15, according to Morningstar.

Recently, ETFs that employ a bearish approach to single-stock investments have experienced losses.

But performance over time isn’t really the point.

The market for these vehicles is primarily composed of traders and individual investors with an extremely high risk tolerance. While there are other methods to gain leverage without paying fees in the 1% range, for some inexperienced retail investors, a single-stock ETF can be a safer option. However, Armour cautioned that it is not a wise long-term strategy and is a costly way to gamble in the stock market.

The SEC’s warning to retail investors

According to Ed Egilinsky, head of sales and distribution and alternatives at Direxion, these vehicles are suitable for experienced retail investors and professionals who are willing to adopt a short-term perspective and closely monitor their investments on a daily basis.

"These are not products for those who want to purchase and forget about them," he stated.

The SEC issued a warning to investors in August about the risks associated with single-stock ETFs, specifically highlighting the amplification of price movements in leveraged single-stock ETFs, which can result in greater volatility and risk for investors compared to holding the underlying stock.

To achieve your investment goals with these products, it is crucial to comprehend whether you are investing or hedging, as stated by Lee. Many individuals use leveraged products for intraday exposure or hedging purposes.

Which stocks could be targeted for the next hotly traded single-stock ETF?

Egilinsky stated that success in the single-stock ETF market is influenced by factors such as assets, daily volume, and scale. Although he did not specify which single-stock ETFs Direxion plans to add next, he mentioned that AI is a promising area. Egilinsky said that the company will continue to evaluate potential additions to its lineup and will let the market determine which single stocks are suitable for launch.