I can think of various nastier ETFs to reject than a spot Bitcoin ETF

ETFs invest in many things that at least raise the question of how beneficial they are to the (American) people, including some that have cost investors billions.

Yesterday, I posted the following on X in response to a letter from Better Markets, which claims to focus on financial reform in the interest of the American people.

https://twitter.com/jsblokland/status/1743987973824102403

In their letter, they argued that the SEC should reject spot Bitcoin ETFs, stating that such an ETF would 'almost certainly lead to massive investor harm.' Better Markets further argues, 'approving these products would expose millions of American investors and retirees to the very harms that the SEC exists to prevent.' They also noted that 'The SEC must not facilitate the financial carnage that will follow if the crypto industry is allowed to repackage, …, a financial product that is little more than a socially worthless gambling chip.'

Obviously, Bitcoin maximalists went berserk, citing the inadequacy of Better Markets to provide judgment and (poorly-substantiated) defending the superiority of Bitcoin within a deeply flawed financial system that must collapse at any moment.

An abundance of ETFs that raise questions

However, it made me wonder about ETFs that have been approved, where it's not immediately clear how they serve the interests of the American people or whether the underlying assets they invest in are truly beneficial. Based on this consideration, I compiled the above list, which is by no means exhaustive. There are ETFs that invest in alcohol and tobacco, undoubtedly among the most harmful legalized drugs that contribute significantly to spiraling out-of-control healthcare costs. Despite numerous sanctions, there are still, mostly emerging market-focused, ETFs that invest in Russia. The list goes on, with ETFs investing in weapons, basic food staple prices, fossil fuels, child labor use and other non-ESG-compliant practices, excess leverage, and more. However, I couldn't find much information on these 'investment areas' on the Better Markets website, though I may have missed them.

To strengthen my argument of whether a particular ETF benefits 'the American people is subjective at best,' I turn to a historical and telling example, partly due to the party involved, where billions of retail investor money was lost in a single day.

Short Volatility ETFs: extremely dangerous investment vehicles

Do you remember the Short volatility/VIX ETFs? These ETFs attempted to generate returns by shorting VIX (the implied volatility of the S&P 500 Index) futures. The idea behind these ETFs is to sell VIX futures at a high price, hence short them, and then buy them back cheaper when they expire.

While everybody understands that stock market investors are long equity, many lack the knowledge that this also means you are short volatility.

When the VIX spikes, stocks typically decline. This is why investors are willing to pay a premium to buy volatility, using VIX futures, effectively hedging their intrinsic short volatility position. As a result, implied volatility, as represented by VIX futures, tends to be higher than realized volatility. Hence, the short VIX ETFs can buy back the VIX-future at a lower price when it expires than the price they sold it for, generating a positive return.

That sounds good, in theory. However, in practice, this strategy is akin to 'picking up nickels in front of a steamroller.' It works well for a while until it explodes, and investors get crushed, losing nearly all of their assets. If you think that's an exaggeration, look at the chart below.

On Monday, February 5, 2018, the S&P 500 crashed by a whopping 4.1 percentage points, and the VIX Index more than doubled in a single day. As a result, the two largest short VIX futures ETFs, ProShares Short VIX Short-Term Futures ETF (SVXY) and VelocityShares Daily Inverse VIX Short Term ETN (XIV), closed down by 77% and 93%, respectively, that day. This translated into USD 2.4 billion in market value being wiped out in just one day. USD 2.4 billion!

Credit Suisse: a bad bank!

Less than a week later, Credit Suisse, yup, the Swiss bank that, after a long series of scandals and mismanagement, is no longer with us, liquidated the XIV ETF, resulting in capital destruction of 94%. To be clear, Credit Suisse itself suffered no losses in this epic crash. To make things worse, then-CEO Tidjane Thiam told CNBC that investors who chose to speculate against the VIX Index did so at their own risk and that 'it worked well for a long time until it didn't, which is generally what happens in markets.' The XIV prospectus was 179 pages long, and I am fairly certain that no retail investor ever read it, and therefore, they didn't understand what they were investing in.

And what about the ProShares SVXY ETF? It still exists, albeit in a modified form, with the leverage reduced from 1 to 0.5, but you can still buy it by pushing a few buttons in your brokerage account. With a market value of nearly $270 million, there are still plenty of investors - many of whom will not understand at all what it is they are investing in – who have done so.

A lot can happen in Bitcoin, but based on historical price data, the likelihood of its value dropping by 80% or 90% in a single day is negligible.

DYOR!

Better Markets may have also warned against these ETFs, although I couldn't find any on various searches. However, the reality is that there are many ETFs whose benefits to the American people are not always clear. In the case of a Bitcoin ETF, I see several aspects that would align with that principle. The most crucial one is that SEC approval would subject spot Bitcoin ETFs to regulatory oversight. One may assume – though not a given – that regulation will inherently be better than it currently is, and the likelihood of (price) manipulation will decrease. This is a major aspect of the ongoing back-and-forth between the SEC and ETF providers and has led to several key ETF proposal adjustments.

To end with a bang, to my understanding, short VIX futures ETFs were NOT regulated by the SEC. As for the inaccurate assumptions that Bitcoin is heavily involved in fraud or is a worthless gambling chip, I will address those another time.

In any case, no matter what underlying asset you are looking at, always 'do your own research' and get help, if needed, before investing! Thank you for reading.

Jeroen