[Inside Chodong] The Double-Edged Sword of "Leverage"

Stock Market Volatility Surges After Launch of Single-Stock Leverage ETFs

Concerns Over Losses for Individual Investors; Additional Safeguards Needed

Changhwan Lee, Deputy General Manager of Securities Capital Market Department

Jesse Livermore, the legendary American stock investor, made a fortune in the early 1900s by actively using leverage (investing with borrowed money) and short selling. He started with nothing, and reportedly earned billions of dollars in today’s terms, reaching the pinnacle as an individual investor. However, excessive leverage proved toxic, and after several bankruptcies, it is known that he ended his life tragically.

Leverage can be a shortcut to becoming wealthy ahead of others, but it is also a 'double-edged sword' that can lead to financial ruin much faster. Warren Buffett, another investment guru, noted that leverage is the primary reason why smart and capable people suffer devastating losses in the market. Buffett even said, "There are only three ways a smart person can go broke: liquor, ladies, and leverage. Of the three, leverage is especially dangerous."

Korea’s stock market is also stirred up by leverage. In May this year, single-stock leveraged exchange-traded funds (ETFs) based on Samsung Electronics and SK hynix were launched for the first time on the domestic stock market. As market volatility increased and the market plummeted, many investors suffered heavy losses. Most individuals who invested in single-stock leverage ETFs experienced losses, and many even saw their principal wiped out, leaving their accounts with nothing. Rather than becoming wealthy faster through leverage, it turned out to be a shortcut to bankruptcy.

Is it fair to put all the blame for these losses on individual investors? Not entirely. The government set the stage for this to happen. While the recent steep market downturn cannot be attributed solely to single-stock leverage ETFs, it is clear that they played a role in amplifying volatility. Bloomberg assessed that this year, the KOSPI Volatility Index reached 60%, making Korea’s stock market the most volatile among major global markets. Bloomberg highlighted that the Korean equities market has transformed into an 'ultra-high-risk trading field,' not a healthy source of capital raising, driven by short-term speculative inflows and outflows and dominated by leverage. Major global investment banks such as Goldman Sachs and JP Morgan have also analyzed that single-stock leverage ETFs deepened the market correction in Korea.

The circuit breaker, which is designed to control market volatility, has been triggered 13 times in Korea’s stock market history, with five of those occurring after the launch of single-stock leverage ETFs. This has fueled criticism that the government underestimated the risks of single-stock leverage products and was too hasty in rolling them out to the market. Ultimately, individual losses on leveraged products appear to stem from both the greed to become wealthy quickly and the government’s hasty launch of these products.  

It has gotten to the point where the CEO of an asset management company has publicly urged individuals to refrain from buying single-stock leverage ETFs. The fact that CEOs of companies selling those ETF products are advising against investment shows how seriously the risks are regarded even at the point of sale. The government has announced plans to implement measures to address the shortcomings of single-stock leverage ETFs, but critics say that the proposed measures may not be sufficiently effective. It seems prudent to prepare additional measures in advance in case the impact proves inadequate.

This content was produced with the assistance of AI translation services.