In the vast landscape of exchange-traded funds (ETFs), the surge in popularity for MicroStrategy (MSTR) due to its aggressive Bitcoin (BTC) acquisition strategy has unveiled unique operational challenges, particularly within the leveraged ETF sector. MicroStrategy, now holding $43 billion in Bitcoin, has become a focal point for investors seeking indirect exposure to cryptocurrency through stock investments. According to TipRanks, this has significantly impacted two U.S.-listed leveraged ETFs, the T-Rex 2X Long MSTR Daily Target ETF (MSTU) and the Defiance Daily Target 1.75x Long MSTR ETF (MSTX), which aim to double the daily returns of MSTR’s stock.
The performance of these ETFs has diverged from their intended tracking accuracy, with notable tracking errors emerging since mid-November. For example, on November 21, MSTU experienced a 25.3% decline when it should have only decreased by 18.3% based on MSTR’s 16% drop. Similarly, on November 25, while MSTR fell by 4.4%, MSTU lost 11.3%, indicating a significant deviation from expected performance. MSTX also saw its returns misalign, with a 13.4% drop on the same day, which was 4.7 percentage points more than anticipated.
The root of these tracking errors can be traced back to the ETFs’ scale and the mechanics of their operations. Both funds have seen their asset bases swell due to the Bitcoin hype, leading to a demand for total return swaps that exceeds what prime brokers can supply. These swaps are essential for accurate tracking, allowing funds to mirror the performance of an asset without holding it. With swaps in short supply, the ETFs have increasingly turned to call options, which do not provide the same precision due to their nature of offering rights rather than obligations to buy at a set price, leading to discrepancies under high volatility conditions as noted by TipRanks, citing FactSet’s Elisabeth Kashner.
Dave Mazza from Roundhill Investments told the FT that this issue is not a general flaw in ETFs or even leveraged ETFs but specifically related to the unique situation with MicroStrategy. The ETFs’ exposure to more than 10% of MSTR’s market cap has pushed them into uncharted territory, making it difficult for financial institutions to support such high-risk strategies with additional swaps.
Despite these operational hiccups, the sentiment around MSTR stock remains overwhelmingly positive. Analysts have given it a ‘strong buy’ consensus, buoyed by its strong year-to-date performance, which has seen its stock value increase by nearly 470%. The average price target of $529.57 set by analysts suggests that there’s still significant upside potential, with an expected rise of 48.3% from the stock’s last traded price of $357.25.
This scenario illustrates the complexities of managing leveraged ETFs in a highly volatile market environment, especially when linked to assets like MicroStrategy, whose fortunes are so closely tied to the unpredictable movements of Bitcoin. It’s a reminder of the need for investors to understand not just the potential returns but also the mechanics and risks associated with such financial instruments.
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