As more investors buy single-stock leveraged exchange-traded funds (ETFs) that track Samsung Electronics and SK hynix at twice their share-price moves, an analysis said that blindly holding them long term or adding emotionally after losses can make it harder to recover principal. Because leveraged products accumulate a "negative compounding effect" as declines and rebounds repeat, investors should set funding rules in advance based on the maximum drawdown (MDD).
Seol Tae-hyeon, a researcher at DB Securities, said in a report on the 5th that "loss-avoidance psychology during a share-price decline disrupts objective stop-loss and rebalancing points and triggers unplanned capital injections," adding, "It is necessary to establish a quantitative response framework based on data, excluding intuition or vague expectations of a rebound."
MDD is an indicator that shows how much a share price has fallen from its peak. For example, if a 100,000 won share price drops to 70,000 won, the MDD is 30%. The report analyzed, based on past prices, how the time to recover principal changes when additional investment capital is deployed differently by loss range.
The biggest risk of single-stock leverage is that even if the underlying stock returns to its original price, the leveraged product may not recover to the same level. Because leverage tracks twice the daily return, volatility decay accumulates when prices repeatedly fall and rebound.
For instance, if the underlying stock falls 10% in one day and then rises 11.1% the next day, its price returns to the original level. But a 2x leveraged product falls 20% the first day and then rises 22.2% the next day, still short of its initial price. The longer a bear or sideways market lasts, the more this negative compounding effect builds, slowing principal recovery compared with the underlying.
The past bear-market patterns of Samsung Electronics and SK hynix also differed. Samsung Electronics showed a relatively moderate decline and gradual recovery, while SK hynix exhibited a high-volatility pattern, falling deeper and then rebounding faster.
In market downturns, the share of time when Samsung Electronics and SK hynix were both in decline was only 44.6% and 30.5%, respectively. Even within semiconductors, price trajectories differ, so investors should not respond to leveraged investments using the same criteria.
Injecting additional capital lowered the average purchase price and shortened the time to recover principal. When Samsung Electronics' spot share price fell 30%–35% from its peak, the median time to recover principal was 253 trading days without additional investment. Adding 50% of the initial investment cut the recovery period to 184 trading days.
The difference was larger in SK hynix leverage, which is more volatile. If a 2x SK hynix leveraged product fell more than 45% from its peak and no additional capital was invested, it took 1,260 trading days to recover principal. By contrast, adding 30% of the initial investment shortened the recovery period to 152 trading days.
However, this result should not be interpreted to mean investors must always buy more in loss ranges. If investors inject funds at every loss without securing additional capital from the outset, concentration in a particular stock and the size of losses can grow.
The report's analysis also applied twice the daily closing return of the underlying stocks, not actual ETF prices. In reality, volatility decay and tracking error can occur, so the principal recovery period may be longer than suggested in the analysis.
Seol said, "Unconditional long-term holding undertaken while in a loss after buying near the peak significantly reduces the probability of recovering principal due to the structural decay of leverage," adding, "Investors should manage market risk quantitatively by considering the recovery period and probability by MDD level and the share of additional investment capital."