The recent spotlight on MicroStrategy and its ties to Bitcoin has revealed weaknesses in the $15 trillion exchange-traded fund (ETF) market. Two leveraged funds, the T-Rex 2x Long MSTR Daily Target ETF (MSTU) and Defiance’s Daily Target 2x Long MSTR ETF (MSTX), have been delivering unexpected results to investors due to cracks in the system.
These ETFs, designed to deliver double the daily returns of MicroStrategy shares, have seen their performances deviate significantly from expectations in recent weeks. The problem lies in the sheer size of these funds, which have become too large for prime brokers to handle. As a result, the supply of swaps used to track MicroStrategy’s stock performance has dried up, forcing fund managers to rely on less accurate call options.
This reliance on call options has introduced massive tracking errors, with the funds losing up to three percentage points more than expected. Analysts like Dave Mazza of Roundhill Investments warn that these ETFs now hold exposure worth over 10% of MicroStrategy’s market cap, a level that the company may not be able to handle.
The surge in MicroStrategy’s stock price, driven by its massive Bitcoin holdings and surging demand for Bitcoin exposure, has pushed these ETFs to their limits. While the funds have managed to stay afloat by transitioning to call options, the accuracy of their tracking has suffered as a result.
Experts like Kenneth Lamont of Morningstar compare the situation to previous ETF disasters, such as the 3x Tesla ETP by Leverage Shares. In order to address these issues, some suggest that stopping new unit creations could help stabilize the funds, although this may come at the cost of growth.
Ultimately, the MicroStrategy ETF situation serves as a cautionary tale for the ETF market, highlighting the risks of rapid growth and the importance of maintaining accuracy in tracking underlying assets. As the popularity of Bitcoin and other cryptocurrencies continues to grow, it is crucial for fund managers to find a balance between growth and precision to avoid similar pitfalls in the future.
