The Impact of Leveraged and Inverse ETFs on Underlying Real Estate Returns

Abstract

Leveraged and inverse ETFs (LETFs) were introduced in 2006. By 2008 there was concern that the requirement of LETFs to rebalance near the close might have a significant impact on the prices of the stocks in the underlying indexes. We examine the impact of trading activity induced by six real estate-related LETFs on the late-day price dynamics of 63 real estate sector stocks. Through a comparison of sample and control stocks and through a regression model of LETF rebalancing, we find that these LETFs significantly impact the prices of component stocks, increase their volatility and contribute to price momentum.

Exchange Traded Funds (ETFs)

“…Several studies have attempted to test the claim that leveraged ETFs create a price impact when rebalancing their portfolios. Bai, Bond, and Hatch (2015) focus on the real estate sector and find that rebalancing by leveraged ETFs increases the volatility of the underlying stocks and contributes to price momentum. Tuzun (2014) ETFs.…”

“…They show that flows into ETFs counterbalance the hedging demand of ETFs, mitigating their effects on the underlying securities. Despite this compelling argument, the effects documented by Bai, Bond, and Hatch (2015) and Shum, Hejazi, Haryanto, and Rodier (2016) use net rebalancing, i.e., after flows in the opposite direction are taken into account.…”

Are Concerns About Leveraged ETFs Overblown?

“…3 The basis of the commentators' concerns seems to be a common perception that leveraged and inverse ETFs must rebalance their portfolios in the same direction as the contemporaneous return on their underlying assets in order to maintain a constant leverage ratio. Conventional thinking suggests that by purchasing assets following positive returns and selling assets following negative returns, these types of financial products exert additional upward price pressure on the underlying assets following positive returns and additional downward pressure following negative returns (see, e.g., Cheng and Madhavan (2009), Bai, Bond, and Hatch (2014), Tuzun (2014), and Shum et al (2014)). However, such reasoning is incomplete because it overlooks the effects of capital flows.…”

Introduction to the Special Issue

“…Anecdotes from market participants during 2008–2009 suggested that REIT stock prices predictably surged near the end of each trading day, up or down in accordance with movements earlier the same day, as LETFs moved to rebalance their portfolios. Bai, Bond and Hatch () report empirical evidence to support the anecdotes: By matching sampled REITs that were constituents of an index followed by an LETF with a control group of similar nonconstituent stocks, they show that sample stocks experienced greater increases in trading activity, volatility and near‐term momentum, especially late in the day and especially during the historical period when real estate‐focused LETFs were becoming more prominent. Indeed, the authors estimate that trading activity induced by LETFs had a median impact of 234 basis points during the last hour on the typical REIT stock on days with relatively high REIT volatility…”

“…While Sun, Titman and Twite () focus on balance sheet management as an internal factor in the severity of stock price declines, the second paper by Bai, Bond and Hatch () focuses on an external factor: the prevalence in the market of leveraged and inverse exchange‐traded funds (LETFs). Anecdotes from market participants during 2008–2009 suggested that REIT stock prices predictably surged near the end of each trading day, up or down in accordance with movements earlier the same day, as LETFs moved to rebalance their portfolios.…”