Raw Material ETF·ETN Trading Volume Triples... Financial Supervisory Service Issues Consumer Alert

[Asia Economy Reporter Ji Yeon-jin] The Financial Supervisory Service (FSS) issued a consumer alert on the 17th regarding investment caution for commodity exchange-traded funds (ETFs) and exchange-traded notes (ETNs) due to significant volatility in raw material prices such as crude oil amid the recent Ukraine crisis.

Recently, as international commodity prices including crude oil have experienced sharp fluctuations, the trading volume of related ETFs and ETNs has surged significantly. From the 1st to the 11th of this month, the average daily trading value of these ETFs and ETNs reached 175.2 billion KRW, a 183% increase compared to the previous month's average daily trading value of 62 billion KRW. The average daily trading value by individual investors was 94.8 billion KRW, tripling from 33.6 billion KRW in the previous month. Individual investors concentrated their trades on crude oil products (71.5%), with particularly high-risk (inverse) leverage (±2x) products accounting for 46.8% of the trades.

The West Texas Intermediate (WTI) crude oil futures price surged from $88.15 per barrel on January 31 this year to $123.70 on the 8th, then dropped to $96.44 on the 15th.

This volatility in commodity prices is expected to continue until international issues are resolved, increasing the investment risks associated with related ETFs and ETNs, thus requiring special caution.

In particular, since the returns of leveraged and inverse ETFs and ETNs are determined by multiplying the returns of the underlying assets by a leverage or inverse multiple, investment losses can rapidly expand in volatile commodity market conditions. Especially when the underlying assets repeatedly rise and fall, causing high volatility, leveraged and inverse ETFs and ETNs experience a 'compounding effect' where cumulative returns are lower than the underlying asset returns due to the nature of the products.

For example, if the underlying asset price falls from 100 to 80 (20%↓) and then rises back to 100 (25%↑), the price of a 2x leveraged ETF or ETN would fall from 100 to 60 (40%↓) and then rise to 90 (50%↑). In this case, while the cumulative return of the underlying asset over two days is 0%, the leveraged ETF or ETN incurs a 10% loss. The same applies to inverse or inverse leveraged products.

Additionally, if a sudden surge in short-term investment demand causes supply-demand imbalances, the premium/discount rate of ETFs and ETNs may widen, leading to investment losses. The premium/discount rate refers to the difference between the market price at which ETFs and ETNs are traded and their intrinsic value. An expanding positive premium indicates that the product price is overvalued, making it difficult to realize expected returns even if the underlying asset rises. When the overvalued market price converges back to intrinsic value, losses equivalent to the premium/discount difference may occur.

ETF and ETN investors should check exchange information related to trading, such as the designation of investment caution items. For instance, the 'Daeshin Inverse 2X Nickel Futures ETN (H)' was suspended from trading as the closing price of its underlying asset, the 'S&P GCSI Nickel 2X Leverage TR' (a futures index tracking -2x the nickel price), dropped to zero on the 8th, making intrinsic value calculation impossible. Also, three oil-related ETNs were designated as investment caution items this month due to premium rates exceeding 12%.

An FSS official stated, "The Financial Supervisory Service and Korea Exchange are strengthening monitoring for abnormal signs in commodity-related ETF and ETN products and plan to take responsive measures such as issuing additional consumer alerts if necessary."

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