Several leveraged exchange-traded funds (ETFs) have been flagged as investment caution stocks following price distortions that occurred during the closing single-price auction session. The Korea Exchange (KRX) acted to alert investors after the gap between market price and net asset value (NAV) widened sharply amid a quote vacuum left by liquidity providers (LPs).
According to the Korea Exchange on Tuesday, the previous day saw three single-stock leveraged products — the ACE SK hynix Single-Stock Leverage, the KIWOOM SK hynix Futures Single-Stock Leverage, and the 1Q SK hynix Futures Single-Stock Leverage — along with the HANARO KOSDAQ150 Futures Leverage, classified as investment caution stocks.
These products saw their real-time tracking error at market close widen to more than double the management-obligation standard set by the exchange. Tracking error refers to the difference between an ETF's market price and its net asset value (NAV), the actual value of its assets. The exchange sets the tracking error management standard at 3 percent for domestic-asset ETFs and 6 percent for overseas-asset ETFs, and these flagged products exceeded twice those standards.
The flagging is interpreted as reflecting the impact of price distortion that occurred during the closing single-price auction session on Monday. ETFs typically have LPs offer bid and ask quotes to narrow the gap between market price and NAV, but that obligation is waived during single-price auction sessions (8:30 to 9 a.m., 9 to 9:05 a.m., and 3:20 to 3:30 p.m.).
In this process, market-order buying concentrated on some ETFs with low trading volume and thin order books, pushing prices to levels far removed from their actual value, according to analysis. In fact, the ACE SK hynix Single-Stock Leverage surged during Monday's closing single-price auction, finishing at 30,000 won, up 49.7 percent from the previous trading day. This was the opposite of SK hynix's 7.68 percent plunge.
The aftereffects of the price distortion appeared immediately on the next trading day. On Tuesday, the ACE SK hynix Single-Stock Leverage traded at 21,890 won, down 27.03 percent from the previous trading day. With the tracking error based on the previous day's closing price having soared to 90.18 percent, the sharp drop is interpreted as occurring during the process of the market price normalizing to the level of actual asset value. By contrast, other single-stock leveraged products of the same type posted returns in the 20 to 30 percent range on Tuesday as SK hynix surged 15.9 percent.
"Tracking error problems for ETFs during single-price auction sessions have occurred intermittently, but this case was one where the concentration of supply and demand during the single-price auction session appeared in extreme form," an industry official said. "Managing the tracking error of single-stock leverage products requires continuous communication with LPs."
The exchange manages ETFs with widening tracking error through a "flagging → designation notice → designation" procedure. If designated as an investment caution stock, single-price trading is implemented in three-trading-day units.
