You can’t argue with success, and a 260% return in just three years certainly qualifies as success. That’s the return that investors in Japan have enjoyed on the Nikkei 225 Leveraged Index ETF since its launch in October of 2012.
Moreover, investors that sold at the peak around two months ago actually saw a more than 370% return in 34 months. Those are the kind of returns you expect to see if you get lucky in a penny stock or a small cap biotech, and not what you typically see from an ETF in a major global blue chip index.
Nikkei 225 ETF popularity is booming, which is a problem
The scintillating 260% return of the 2X Nikkei 225 ETF is actually over two times the return of the index, due to the compounding effect.
There are certainly significant risks in investing in leveraged funds, but can you blame the Japanese for leveraging up when an Abenomics-inspired spending spree has led the central bank buying $25 billion worth of stock ETFs a year?
Also keep in mind that the almost the same thing transpired in the U.S. when the Fed was pumping liquidity into the system via its 2012-2015 QE program. The U.S. ProShares Ultra S&P 500 ETF grew to a gigantic $3.5 billion while returning over double the S&P 500 over the three years.
However, too many cooks in the kitchen can spoil the pie, and that truism is also hitting home in this case. Over the last 36 months, the 2x Nikkei 225 ETF run by Nomura has swollen to $6.8 billion in assets, making it the world’s largest leveraged ETF by a large margin.
The fund, however, has become too large of a buyer in the futures market, which led to the halt new creations of the ETF. This means the ETF will trade like a closed-end fund until/if further creations re-open.
In prior cases where ETFs that grew too big for their futures markets and had to halt creations, the ETF was eventually re-opened by using a derivative called a total return swap to reach its level of leveraged exposure. Whether this fund can or is willing to do take that step remains uncertain.
Another important consideration for investors, of course, is whether or not the Bank of Japan will implement more stimulus, which would help boost Japanese markets. A decision regarding additional stimulus is expected at the Oct. 30 BOJ policy meeting.
