(Oct 2): Add another item to the list of things low volatility is doing to the market: record amounts of exchange-traded fund closures.

Forty-two ETFs were set to close by end-September, the most ever in a single month, according to data compiled by Bloomberg. Of those, 21 are leveraged or inverse funds, which tend to attract investors when prices are volatile but can fall out of favour when stocks are as calm as they have been all year.

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Direxion’s Daily Homebuilders & Supplies Bear 3x ETF closed on Sept 25. The ETF, which makes leveraged bets that homebuilders’ stocks will fall, has been drained of assets this year as the sector has charted a steady upwards course. It has shrunk to just US$1.36 million ($1.8 million) in assets, down from $7.83 million at its peak in February 2016.

“For traders, volatility represents movement and therefore opportunity, but when there’s very little volatility, these products don’t get as much use,” says Andy O’Rourke, chief marketing officer for Direxion.

Wall Street banks such as Citigroup are blaming unusually calm markets for their poor trading results this quarter. Not even mounting tensions with North Korea or deadly US hurricanes have been enough to trigger substantial volatility among stocks. On Sept 18, CBOE’s Volatility Index (VIX) fell below 10 for the first time since August.

Milwaukee-based Direxion shuttered 12 leveraged and inverse ETFs last month, according to a company release. Besides the Daily Homebuilders fund, there were the Direxion Daily Silver Miners Index Bear 2X Shares fund, a leveraged ETF tracking the stocks of silver miners, and the Direxion Daily Healthcare Bear 3x Shares fund.

“All ETFs tend to trade more when there’s more volatility, but definitely leveraged products,” says Eric Balchunas, an analyst at Bloom berg Intelligence. “When those kinds of volatile swings aren’t happening, it’s just not as fun a game to play.”

Of course, with leveraged and inverse ETFs, it can sometimes seem like the spaghetti cannon is set permanently at 11, which means closures occur more often than usual. Among last month’s planned delistings was the Direxion Daily Cyber Security & IT Bull 2x Shares fund, with US$5 million in assets.

Coincidentally or not, the Daily Cyber Security fund, which is two-times leveraged, was launched in September 2015, just a few months after the ETFMG Prime Cyber Security ETF, an unleveraged fund tracking cybersecurity companies, ballooned to more than US$1 billion in assets. A massive computer breach at Sony Pictures Entertainment spurred investors to pour money into companies in the business of thwarting such attacks.

While Daily Cyber Security used this momentum to keep growing, at one point climbing to more than US$1.4 billion in assets, it never expanded beyond US$6 million.

Issuers of inverse and leveraged ETFs often “overestimate the market’s demand for leveraged, where it’s just too early in some cases”, says Balchunas. But sponsors of the products, which represent about 2% of ETF assets and 9% of trading volume, are in a unique position to shoulder that risk. Such issuers do not necessarily have to compete to have the lowest fees because users hold the products for as little as a few hours.

“One thing people don’t realise is how much money leveraged issuers make, and how they don’t have to play the fee war game. If anyone can trial-and-error, launch-and-close, it’s leveraged issuers,” says Balchunas.

Ironically, leveraged ETFs linked to the VIX have rarely had it better. The VelocityShares Daily 2x VIX Short Term ETN and ProShares Ultra VIX Short-Term Futures ETF collectively received US$337 million of inflows two weeks ago, the most since 2016. Traders seem more willing or able than fund providers to bet on a resurgence of market jitters.

Other firms that shuttered funds last month included Elkhorn Investments, VanEck Vectors and ProShares Advisors, which is closing 13 ETFs, including nine inverse and leveraged funds.

Still, just because some funds are closing does not mean providers are giving up on them. Direxion’s O’Rourke still believes there is potential for a leveraged ETF on the cybersecurity theme, similar to Daily Cyber Security. “We still think it’s something that may have some legs to it,” he says. — Bloomberg LP

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