The SEC should ban the products behind South Korea’s recent market meltdown

In South Korea, financial regulators recently approved investment products allowing leveraged access to the nation's two largest stocks, Samsung and SK Hynix. Designed to entice investors away from similar US products, these leveraged single-stock exchange-traded funds (ETFs) provided double the return of the underlying stocks. However, the timing was unfavorable, as both stocks experienced significant gains earlier in the year.

As retail investors poured $9.4 billion into these funds within two months, the underlying tech stocks faced a correction due to diminishing confidence in AI and increasing competition from China. This led to steep declines in the price of Samsung and SK Hynix stocks, which in turn caused significant losses for investors in leveraged ETFs.

These ETFs, designed to double the gains and losses of the underlying stocks, suffered from a phenomenon known as volatility decay, where the ETFs rebalance daily to provide double the stock's return, leading to greater losses during volatile markets. By the end of a year, these ETFs would still be down between 63% and 75% compared to the stocks that would recover to their original prices.

This issue is not unique to South Korea. Similar leveraged ETFs tracking tech stocks like Nvidia, Tesla, and Microsoft have also amassed $65 billion in assets, with a majority of trading coming from retail investors. Despite the SEC's awareness of the issues, no mandatory educational requirements exist for retail investors in the US, unlike in South Korea.

The SEC is currently reviewing its ETF rules, including those for single-stock leveraged ETFs, and has an opportunity to take action to protect American retail investors before a similar market meltdown occurs.