A leveraged game of wealth creation and destruction continues to attract retail investors.
After surging tenfold and then plummeting by seventy percent, the leveraged frenzy in the South Korean stock market has finally begun a severe correction.
On July 16th, South Korean stocks opened sharply lower, once again triggering a market-wide circuit breaker. This occurred just three trading days after the previous market-wide halt. Over the past month, circuit breaker alarms have sounded frequently in the South Korean market, even resulting in two halts in a single day.
The severity of the decline matches the intensity of the previous rally, a fractured market situation that fully illustrates the true nature of leveraged markets. In less than twenty trading days, SK Hynix Inc. (KRX: 000660) fell by less than forty percent, while a 2x long leveraged ETF tracking it fell by nearly seventy percent over the same period.
"To maintain a fixed leverage multiple, leveraged ETFs mechanically adjust their positions daily, increasing holdings when prices rise and decreasing them when prices fall. This mechanism inherently makes leveraged ETFs prone to 'buying high and selling low', buying more as prices rise and selling more as they fall," said a securities strategy analyst.
The massive drawdown and extreme volatility have not deterred investors; instead, they have fueled an even stronger desire to increase positions. Wind data shows that as of July 15th, the fund size of the XL 2X Long SK Hynix ETF reached a record high of 928 million units since its inception. Trading activity has also remained high, with daily turnover this month consistently exceeding HKD 10 billion, peaking at over HKD 23.5 billion.
Understanding the Leveraged Game
The key to understanding leveraged ETFs lies in the "double leverage" daily rebalancing mechanism, the analyst noted. These ETFs aim to track "daily multiples," not "long-term multiples."
Taking the XL 2X Long SK Hynix ETF (HKEX: 07709) as an example, the "2x Long" in its name refers to seeking, before fees and expenses, to deliver twice the daily performance of SK Hynix Inc.'s share price. In other words, if the stock rises 5%, the ETF aims for a roughly 10% gain, and vice versa.
Riding the wave of the AI memory boom earlier this year, SK Hynix Inc. began a rally, and the XL 2X Long SK Hynix ETF surged alongside it, with its peak gain approaching 1062%. The tenfold surge in six months quickly made such products a "wealth creation tool" chased by retail investors, with the product's size once exceeding HKD 130 billion, making it the largest ETF in the Hong Kong market.
However, as the tide receded, the dual nature of leverage was fully exposed. Wind data shows that as of July 16th's close, SK Hynix Inc. has fallen nearly 37% since June 23rd, with a maximum drawdown approaching 44%. In contrast, the XL 2X Long SK Hynix ETF has experienced a 70.5% drawdown from its high, with a maximum drawdown nearing 75%.
Amid South Korean market volatility and the effect of leverage, this leveraged ETF has shown extreme price swings. For instance, over the recent three days from July 14th to 16th, the ETF's cumulative return was -5.71%, yet it saw a maximum intra-period gain exceeding 67% and a maximum drawdown exceeding 32%.
Consequently, the fund's size has also retreated to HKD 70.85 billion, a 46% decrease from the HKD 132 billion recorded on June 22nd. The XL 2X Long Samsung ETF (HKEX: 07747) shows a similar pattern, falling nearly 60% over the same period with its size also shrinking by nearly 46%.
Mechanics of Amplified Volatility
Why do these products possess such destructive power during downturns? The key lies in their unique operational mechanism.
A team from China Merchants Securities led by Li Haoyang holds a similar view. Their analysis indicates that the rebalancing operations of leveraged ETFs are essentially a process of "buying high and selling low." The daily rebalancing of single-stock leveraged ETFs in South Korea inherently has a pro-cyclical, downward-amplifying effect in falling markets. The concentrated exposure resulting from zero-barrier retail inflows further magnifies the impact of these rebalancing trades.
"After rapid scale expansion, the daily rebalancing mechanism of leveraged ETFs amplifies both the rise and fall of individual stocks," the aforementioned securities analyst added. For specific stocks, the trading volume triggered by a leveraged ETF in a single day can account for half of that stock's total daily turnover. If the scale of leveraged ETFs remains at current levels, they will continue to accelerate market movements during both sustained rallies and sharp declines.
Simultaneously, a core misconception among many investors is confusing "daily double leverage" with "holding period double leverage." This means that as long as the underlying asset exhibits volatility, a gap between these two measures is inevitable, and the direction of this gap typically erodes net asset value.
For example, during the period from July 9th to 15th, SK Hynix Inc. rose slightly by 0.29%, while the XL 2X Long SK Hynix ETF fell 13.25%, with its net asset value per unit dropping from HKD 89.24 to HKD 76.39.
Somewhat unexpectedly, the significant drawdown and volatility have not scared off investors; instead, the willingness to add positions has continued to strengthen. Based on Wind data, since the beginning of July, the fund units of the XL 2X Long SK Hynix ETF have seen daily net increases, reaching a record high of 928 million units as of July 15th.
Furthermore, the product's trading volume has further expanded. Data shows that as of July 16th, the XL 2X Long SK Hynix ETF maintained a daily turnover above HKD 10 billion for eight consecutive trading days. Its average daily turnover this month reached HKD 16.772 billion, a 25% increase from the previous month's average.
It is understood that such single-stock leveraged products were not designed for ordinary investors from the outset. CSOP Asset Management also states on its website that single stock leveraged and inverse products are intended for short-term trading or hedging and should not be held for more than one day. This is because the product's performance over periods longer than one day may deviate from and be uncorrelated to the leveraged performance of the underlying stock over the same period, making them unsuitable for long-term investment.
"The product is concentrated in a single underlying stock. Given its non-diversified and leveraged nature, the product price is extremely volatile and may become non-viable within a short period. Investors may lose a substantial portion or all of their investment within a single day," CSOP stated. The target investors for these products are limited to those sophisticated in investments, primarily traders, who understand the potential consequences of seeking daily leveraged returns and the associated risks, and who monitor their holdings frequently on a daily basis.
Factors Behind South Korea's Market Vulnerability
While the leveraged ETF mechanism is a volatility amplifier, the unique market structure of South Korean stocks further magnifies its destructive power.
In the view of industry insiders, the South Korean stock market exhibits a clear technology industry orientation and a top-heavy concentration effect. Its highly concentrated industry structure, combined with an investor base dominated by retail investors and foreign capital, collectively determines that it is a high-volatility market highly susceptible to the global semiconductor cycle, market sentiment, and US dollar liquidity.
Wind data shows that as of July 15th, there are over 830 listed companies on the South Korean main board. The combined market capitalization of two tech giants, Samsung Electronics Co., Ltd. and SK Hynix Inc., accounts for nearly 54%. According to Huatai Securities data, a "retail investor market" is a key characteristic of South Korean stocks, with the median share of individual investors' trading volume reaching 51.5% since 2008.
Regarding leverage risks in South Korean stocks, a team led by Huatai Securities strategist Li Yujie categorizes them into two layers: one layer involves banks and non-banks creating funds for investment in financial markets; the other layer involves these funds flowing into leveraged financial products.
"These two layers of risk may be multiplicative rather than additive, with the segment where both layers are leveraged being the most fragile," the team believes. The second layer, financial product leverage, especially from leveraged ETFs with almost "zero-threshold" subscriptions, has already had a substantive impact on the market.
Faced with intense volatility, South Korean regulators have begun to act. For instance, the Financial Supervisory Service previously stated that as retail investor demand for high-risk products shows no signs of cooling, the side effects of single-stock leveraged ETFs are intensifying, and financial authorities are considering separate stabilization measures for them.
On July 16th, media reported that the Financial Services Commission stated in a declaration that South Korea will suspend the listing of new single-stock leveraged ETF products to curb market volatility. Additionally, regulators plan to temporarily increase the minimum trading unit for single-stock leveraged products from the current 1 unit to 20 units.
In the view of industry insiders, market concerns about leverage in the South Korean stock market primarily stem from the rapidly expanding scale of derivatives, relatively low margin requirements for financing, and increasingly tightening regulation.
"While frequent regulatory warnings aim to prevent systemic risk, market worries that subsequent forced deleveraging could trigger a chain reaction of passive selling by leveraged ETFs have amplified wait-and-see sentiment and selling pressure in the short term. Coupled with the fading AI narrative, market volatility has intensified further," said another industry source.
Ripple Effects Emerging
The spillover effects of South Korean market turbulence have simultaneously transmitted to the A-share market. Related concept sectors such as chips and semiconductor equipment have recently experienced sustained corrections. Data shows that as of July 16th, a semiconductor index has fallen over 22% so far this month.
From an individual stock perspective, Samsung Electronics Co., Ltd. and SK Hynix Inc. are also significant holdings in some cross-border products. Taking QDII funds as an example, at the end of the first quarter of this year, 12 QDII products were invested in the South Korean market, with 6 of them holding over 447,000 shares of SK Hynix Inc.. The Huatai-PineBridge China-Korea Semiconductor ETF accounted for nearly half of these holdings.
Benefiting from the semiconductor bull market in South Korea this year, the Huatai-PineBridge China-Korea Semiconductor ETF has attracted significant attention, with a year-to-date return of nearly 97% as of July 15th. Since June, the product has consistently maintained a double-digit premium rate, leading to the issuance of over a hundred secondary market trading price premium risk warnings or temporary trading halts year-to-date.
"Short-term optimism remains, but heightened volatility needs to be guarded against. Market performance is highly likely to fluctuate with the ups and downs of the semiconductor cycle," said a representative from a leading fund company. The South Korean market can be viewed as a high-volatility AI thematic investment tool rather than a stable long-term value market.
At the current juncture, Li Yujie's team cautions that greater pressure on South Korean stocks comes from the high volatility caused by high concentration and high leverage. When global US dollar liquidity marginally tightens and South Korean regulators take a stricter stance on leveraged trading, even minor adjustments can be structurally magnified.
"Although South Korean regulators have intensified risk intervention over the past two weeks, the special mechanism of leveraged ETFs itself increases the difficulty of resolution," the team noted. In their view, product redemption pressure and the "landing" of regulatory measures are risk points requiring attention in the next step. In the medium to long term, the direction of South Korean stocks will still depend on industrial fundamentals.
"The South Korean market can be viewed as a high-volatility AI thematic investment tool, and increased volatility needs to be guarded against going forward," the representative from the leading fund company added. Recently, global tech sectors have shown high interconnectivity, with domestic Chinese tech and semiconductor sectors declining in sync with overseas markets. It is judged that the short-term A-share market will continue in a weak, volatile pattern influenced by external market transmissions.
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