Korea's stock market is going through unprecedented turmoil. The KOSPI, which had topped 9,000, has fallen nearly 40 percent this month, and circuit breakers were triggered on two consecutive days for the first time ever. As the market collapsed, the arrows of blame have turned toward the single-stock leveraged exchange-traded funds (ETFs) tracking Samsung Electronics and SK hynix, which were listed in May this year. In political circles, calls to delist them have even surfaced, and much of public opinion points to these products as the main cause of the volatility.
It is possible that leveraged ETFs amplified stock price volatility, but it is difficult to conclude that they were the main cause of this crash. Major markets such as the United States, the United Kingdom, and Hong Kong also list single-stock leveraged products, yet they are not treated as a major problem there. Even where leveraged ETFs exist, there is a buffer known as market liquidity that absorbs the shock. So why do we lack a buffer to absorb the shock?
Before the launch of single-stock leveraged ETFs, in March this year, I warned in the media that "a market in which the top one or two blue chips by market capitalization swing 10 percent a day is not an object of investment but is closer to a casino." I pointed to the absence of institutions that reduce extreme volatility and supply liquidity. At the time, the KOSPI was setting record highs, so such volatility simply was not regarded as a problem. In other words, the timing does not fit for attributing the KOSPI's volatility to leveraged ETFs.
The data supports this as well. Since the launch of single-stock leveraged ETF products, SK hynix's volatility has been measured at 113 percent, a level similar to that of Micron (122 percent) in the United States and Kioxia (120 percent) in Japan. The July crash, too, is better understood as a global phenomenon in which semiconductor stocks worldwide declined as doubts spread over the artificial intelligence (AI) bubble and profitability. This was compounded by a market structure centered on retail investors with weak capacity to supply liquidity, along with a trading culture focused on short-term speculation.
The bigger problem is that institutional money to supply liquidity is nowhere to be seen. In overseas markets, when a crash comes, deep pools of institutional money such as pension funds, insurers, and hedge funds step in to buy at low prices and absorb the shock. A car driving on an unpaved road can maintain ride comfort thanks to its suspension, and it is precisely this institutional money that plays that role in the market. Korea's stock market right now is like a car without a suspension running down a rough road. Pension funds' rebalancing (asset reallocation) is by its original principle to sell when prices rise and buy when they fall, and is designed to serve this buffering role. However, because weight adjustments were delayed during the bull market, there was no buying power left, and during the July crash pension funds' net purchases came to just 105 billion won. Over the same period, individuals alone absorbed the more than 10 trillion won that foreigners dumped.
Of course, the structural characteristics of leveraged ETFs cannot be ignored either. Because these products trade in the same direction as the market every day to track twice the daily return, they can increase volatility. But the United States has already allowed single-stock leveraged ETFs since 2022, and it has not become a major problem. Because the trading volume of leveraged ETFs is flow unrelated to fundamentals, institutional investors such as hedge funds absorb it. Research by economists at the U.S. Federal Reserve (Fed) also reports that the inflow of bargain-hunting money offsets a substantial part of the market shock.
Leveraged ETFs also have positive functions. With no forced liquidation, they are a safer means of leverage than margin lending transactions. In the case of single-stock products, the so-called "volatility decay effect" can erode returns, but for index products they are not bad even for long-term investing. For example, the triple-leveraged Nasdaq ETF has risen nearly 300-fold since 2010, and it can be a useful wealth-building product for young investors. Even if leveraged ETFs are banned, related products already exist overseas, so it would only push investors toward foreign products. Regulation driven by public opinion must also be guarded against. Financial markets are like living organisms, and regulatory policy can produce unintended results. If single-stock products produced the unintended result of amplifying volatility, a one-sided ban could also become an obstacle to stock price gains in a rebound.
What is needed is not regulation but the advancement of the capital market. We must break away from the practice of setting the index level as the goal and aim for a market that steadily produces returns in the 10 percent range, and pension fund rebalancing must be carried out by the rules regardless of public opinion. Long-term institutional money must be actively steered into the stock market through measures such as true integrated management of retirement pension and pension fund investment pool assets. Only when these funds grow deep will the market finally have the suspension to absorb shocks.
