June 6, 2014 5:35 am JST

Pros keep eyes peeled as individuals crush on leveraged ETFs

TAKESHI KAWASAKI, Nikkei staff writer

TOKYO -- Small investors in Japan have been enamored with leveraged exchange-traded funds of late, a development that market pros think too important to ignore.

     "1570? Yes, there is still active trading," a trader at a major brokerage said Thursday, checking a computer screen. The number is the ticker code of the Nikkei 225 Leveraged Index ETF, managed by Nomura Asset Management and designed to double the changes in the Nikkei Stock Average. The fund recorded the second-highest trading value on the Tokyo Stock Exchange that day, after SoftBank.

     Behind the surge in trading of the Nikkei leveraged ETF is the influx of retail investors.

     "I can't spend much time analyzing individual stocks during the day," says a 40-year-old businessperson here who has allotted half of 4 million yen (nearly $38,500) in investment assets to this instrument alone. "In this sense, the Nikkei leveraged ETF is easier."

     Even compared with the regular Nikkei-linked ETF, the leveraged version "has a fair degree of volatility and is highly efficient in terms of return," the part-time investor notes.

     "With the foreign exchange market growing increasingly stagnant, some individuals who had focused on foreign-exchange margin trading are now moving to the Nikkei leveraged ETF," says Makoto Shiota, head of ETF marketing at Nomura Securities.

     Because leveraged-ETF investors essentially need to follow just stock indexes, the instruments are closer in nature to forex margin trading than to individual stocks. Not all retail investors can spend hours studying companies. Leveraged ETFs can be said to have helped draw a new group of individuals to the market.

     With a market capitalization of some 250 billion yen, the Nikkei leveraged ETF now boasts second-highest balance among the world's leveraged ETFs. So its movements naturally impact the broader market to a certain degree.

     Asset management companies use stock index futures to adjust reference prices of leveraged ETFs. They buy futures when the market rises and sell them when it falls, amplifying market changes.

     When the Nikkei average goes up or down 1%, companies managing leveraged ETFs trade some 15 billion yen in futures, says Naohide Une of Goldman Sachs Japan. The amount is on a par with the impact that hedge funds' orders to buy Nikkei average call options have on the broader market. This is why pro traders say they can no longer afford to overlook fund flows into and from leveraged ETFs and their trading trends.

     One problem is that the Nikkei leveraged ETF alone accounts for a whopping 60% of the total trading value of all 150 or so ETFs on the Tokyo market.