South Korea's Leveraged ETFs Exacerbate Stock Declines

South Korea's financial regulator approved leveraged single-stock exchange-traded funds (ETFs) for its two largest stocks, Samsung and SK Hynix, just over two months prior to the reporting period. These products were designed to offer investors double the return of the underlying stocks, with the explicit aim of attracting local capital away from similar U.S. offerings and repatriating assets. The strategy proved effective in drawing retail investment, with South Korean investors channeling $9.4 billion (14 trillion Korean won) into these leveraged ETFs in less than two months. However, the launch coincided with a challenging period for these key companies. Both Samsung and SK Hynix had experienced significant gains earlier in the year. As retail investors gained access to leverage, global sentiment shifted away from an unquestioning faith in artificial intelligence (AI), and increased competition from China began to cast doubt on SK Hynix's dominant position in the AI chip market. This confluence of factors triggered a correction in the technology sector, disproportionately affecting chip manufacturers such as Micron, Intel, and SK Hynix, as well as Nvidia, a major customer of SK Hynix. On a particularly volatile trading day, Samsung's stock price dropped by 14.7%, and SK Hynix fell by 13.4%. These substantial declines negatively impacted South Korea's heavily concentrated KOSPI index and led to repeated trading halts. The leveraged ETFs amplified these market movements, causing significant distress for investors. The structure of these leveraged ETFs necessitates that their issuers maintain twice the value of the underlying stock at the close of each trading day to provide the promised double returns and losses. This means that as a stock price rises, the ETF issuer must purchase more of it, and conversely, when the stock price falls, they must sell more. This mechanism creates a "volatility loop," where the ETF's trading activity exaggerates price movements in both upward and downward directions. Consequently, investors holding these leveraged ETFs faced substantial losses. Data from South Korea's investment firm Hanyang Securities indicated that between May 27 and July 22, shares of Samsung and SK Hynix declined by 15.2% and 18.4%, respectively, with the leveraged ETFs magnifying these figures for their holders.