YANG ETF: Inverse Leveraged Wager On Chinese Economic Headwinds (2024)

General Introduction

It has been a bit of a stinker for Sino-American diplomatic relations lately. Just a few days ago, a Chinese civilian weather balloon inadvertently strayed off course and found itself taking weather measurements over several sensitive nuclear sites in the western state of Montana. Purely coincidental, naturally.

It culminated in the shooting down of the craft to collective outrage over the other side of the Pacific. I get it. Weather is important, right? The underpinning question was why would it be important to know whether rain or shine in Montana if you are living in Guangzhou?

Anthony Blinken’s subsequent China visit cancellation and the ensuing diplomatic spat now appear to have tarnished already strained relations. Previously, we had Nancy Pelosi figuratively “buzz the tower” by landing in Taiwan to jeers from local onlookers.

If it were NFL, that would be taunting and a loss of 15 yards, yet luckily Nancy got away with a few offshore fly-bys & general military chest puffing. Great balls of fire. It made for riveting viewing for me - at least it was a break from day-trading stonks.

President Biden has been outspoken emphasizing America’s readiness to defend Taiwan by force, a step away from Washington’s once famed strategic ambiguity. That too has amped up tensions between Washington and Beijing, making for an increasingly fraught setting.

The US has brokered deals to have Japanese, Korean and Dutch chipset hardware manufacturers spurn Chinese orders in a lasting step to isolate Chinese technological prowess. AUKUS – a supranational military pact is looking to share arms technology and resources to corral China’s growing geo-political reach. That has resulted in a tariff war with Australia on literally everything, except iron ore. Of course.

And even China has been figuratively beating itself up. President Xi’s domestic tech-sector smack down heaped pressure on China listings abroad. Then rampant Covid lockdowns, part of a zero-tolerance policy, laid siege to China’s industrial engine which powers world exports. All in, it has been pretty grim – even if surprisingly the Hang Seng has been on a recent tear.

So how would you play that if you actively managed risk? Well, consider Direxion Daily FTSE China Bear 3x Shares (NYSEARCA:YANG). It’s that flyby opportunity allowing you to switch from missiles to guns in an all-out bid to deliver positive risk adjusted returns. Even if recent blockbuster Top Gun patched over references to Taiwan on Maverick’s flight jacket in a bid to rekindle relations, little can allay fears that poking the bear may create a full-blown bearish environment.

Queue YANG Direxion Daily FTSE China Bear 3x shares. Great balls of fire.

ETF Overview

Direxion Daily FTSE China Bear 3x Shares is an ultra-leveraged ETF managed by Direxion Investments. It uses synthetically engineered positions to take short exposure to a basket of Chinese risky assets. Those underlying securities provide somewhat of a mix of both growth and value across broader Chinese capital markets. It is a handy wager against Chinese equities listed in Hong Kong’s publicly traded equity market. As its name suggests, this security should only essentially be held “daily”, ruling it out as a buy-and-hold position.

Retaining a holding beyond that, compounding of returns, daily re-sets and path dependency mean the product will not produce expected returns. The fund aims to be selective in its approach to security selection with only approximately 50 underlying Chinese securities – these do not include A-shares traded on the Chinese mainland nor Chinese names solely listed in the United States, often through Cayman-Islands based capital vehicles. Rebalancing of the underlying index tracked by the ETF occurs on a quarterly basis.

It is a powerful tool for capital allocators holding a near-term bearish outlook on China, but it should be avoided by those lacking experience, having limited risk tolerance, or simply seeking buy-and-hold assets.

YANG navigated to large upside shocks over the past 12 months.

ETF Structure

YANG – Direxion Daily FTSE China Bear 3x Shares is part of the family of exotic, inverse equity set-ups. As highlighted, it focuses on a diverse blend of underlying securities specifically linked to China. The ETF aims to track the FTSE China 50 Index while underlying securities follow a market cap weighting. Securities are Hong-Kong listed and the fund touts a distribution yield of 84 basis points.

Derivatives usage is prevalent – mainly OTC swaps, on iShares China Large Cap ETF. That makes understanding the exact underlying holdings kind of tricky and security selection very dynamic – at the time of redacting this article, there were 17 underlying holdings making up about $177M in funds under management. Those numbers are marginal but also reflective of the nature of the product – short term, high turnover, tactical trading instrument.

The market for Chinese ETFs is relatively well developed. YANG remains one of the more exotic set-ups.

Expense ratios are high at 1.00% - this is reflective of the pricier nature of managing a fund made up of actively administered derivative contracts along with reduced holding times and substantial ETF churn. On average, the fund turns over almost $100M of shares on only $177M total assets under management. That is telling of the nature of the product – very tactical, short holding periods, and big churn. Average spreads are not too big (0.08%) for this type of product perhaps due to its near-term trading nature. In summary, this remains a tactical trading instrument that is comparably more costly than standard ETFs, due to the nature and cost of administering a bunch of derivative contracts.

There has been over $200M of fund inflows over the past 6 months as China sentiment has soured.

Because almost all market returns are skewed to the upside – as per the adage of the stock market taking the stairs up and the elevator down – this product is intrinsically designed to implode. Only reverse stock splits ultimately stop this ETF from terminally hitting zero. Given the risk and volatility around options markets, that does not mean that naked calls should be sold against the underlying – this is a perilously risky thing to do, like landing in Taiwan.

Options markets do however provide some optionality – low volatility (where available) deep out of the money long calls are possible, helping money managers capture tail risk created by exogenous shocks. While this is a small, frequent loss strategy, gains while being rare risk being phenomenal. The long position means risk is defined.

Risk

Leveraged ETFs are among the most exotic and risky presently available to money managers. They employ copious amounts of leverage, often using synthetics and generally replicating expected returns through some degree of financial wizardry. That is the real risk here – newbies taking on negative expectations on China, holding YANG and not fully realizing all the pitfalls linked to ultra-leverage.

OTC derivatives are risky – these are derivative contracts agreed between 2 counterparties “over-the-counter”. That means that any aspect of that contract can be customized but, more specifically, there is no clearing house between the 2 institutions. This translates into counterparty risk.

In times of extreme market jitters, contagion can rapidly spread – if in this instance, one of the counterparties were unable to perform their obligations linked to the derivative contract, the leveraged ETF could figuratively explode. It happens only once in a blue moon. But it does occur and when it does, considerable capital destruction ensues.

It’s not just another watered down Top Gun sequel that is a risk - Geo-political risk is big for this product also. Through experience gained during the Ukraine/ Russia conflict, we have observed securities suspended from trading and certain ETFs completely fold. It is not completely clear the legal ramifications behind such action, but capital recovery would perhaps be a lengthy and onerous process.

Key Takeaways

YANG – Direxion Daily FTSE China Bear 3x Shares has often been the go-to for traders looking to short China. Its inverse nature means traders can get short while technically being long. That is great for money managers with investment policy statements preventing them from holding short equity.

For the rest of us, the product does what it says on the tin – it is a daily reset inverse leveraged product with high fees and big risk linked to its makeup. That aside, for those knowledgeable of derivative markets, the options provide some alternatives to delivering positive risk adjusted returns, and figuratively allowing you to switch from missiles to guns. Great balls of fire.

ZMK Capital is a Southeast Asian based prop trading desk focusing on long/ short macro set ups globally. Additionally, the desk publishes equity specific research, ETF overviews, earnings plays and macro-economic analysis.Current focal points include the global energy market, natural resources, macro-economics, interest rates and Fx. Beyond managing money in these markets, interests include data science linked to securities markets, game theory & professional sports.Feel free to direct message ZMK if you are interested in being part of a community of prop traders, investors & money managers.