What happens when you take one of the market’s most highflying stocks and multiply it by two?
MicroStrategy Executive Chairman Michael Saylor at the Bitcoin Conference 2023 in Miami Beach.
The $2.9 billion T-Rex 2x Long MSTR Daily Target exchange-traded fund (ticker: MSTU), which launched on Sept. 18, promises to deliver double the daily return of MicroStrategy, a data-analytics and software company that is the largest corporate Bitcoin holder. Crypto bros consider the company’s executive chairman,Michael Saylor,to be a Bitcoin guru, and the stock is up over 500% this year, well outpacing Bitcoin’s own 123% rise.
“At the end of the day, more leverage is better,” says the ETF’s manager, Matthew Tuttle.
The T-Rex ETF has gathered more assets than its rival, the $1.8 billion Defiance Daily Target 2x Long MSTR ETF (MSTX), even though Defiance’s ETF is older, having launched on Aug. 14. Usually, in the ETF world, the oldest ETF in a strategy gathers the most assets, having a first-mover advantage. The reason, Tuttle says, is that Defiance initially offered less leverage, promising 1.75 times MicroStrategy’s daily return and only shifting to 2x on Oct. 29, after T-Rex became popular.
Such volatile ETFs are built more for day traders than buy-and-hold investors. “What we’ve learned over the years is that the average holding period [for leveraged ETFs] tends to be pretty good in terms of what we’re trying to do,” says Sylvia Jablonski, CEO of Defiance ETFs. “It’s around a day or two. So [our investors] are coming in and out of the product, day trading or actively monitoring their accounts, which is what we want them to do.”
Of crucial importance for anyone considering holding leveraged ETFs for longer than a day is to understand that their returns are what is called “path dependent.” That means while the ETFs should deliver two times MicroStrategy’s returns—or a multiple of another benchmark’s return in a given day—over time their returns will most likely vary from that multiple, depending on the path or price history of the underlying security or index they track. If a stock’s price is volatile but range-bound—rising a lot and falling a lot on sequential days—the returns will likely be disappointing if not strongly negative over time, even if that stock’s total return over the entire period was positive.
Investors saw this problem in the volatile 2020 pandemic and 2022 periods. The popular leveraged ProShares UltraPro QQQ (TQQQ), promising 3x the daily return of the Nasdaq 100 index, lost 20% from Dec. 31, 2019, through Dec. 31, 2022, even as the unleveraged Invesco QQQ Trust (QQQ) gained 25% because of the volatile path the Nasdaq took to achieve that gain.
Conversely, if a leveraged ETF’s underlying security is trending generally in the right direction, the compounding effect of the leverage applied on several sequential positive days can lead to better than 2x returns. That is what has happened to these two MicroStrategy ETFs as the stock has surged in an increasingly crypto-friendly environment. From its September inception through Nov. 22, the T-Rex ETF has delivered a surreal cumulative 720%, more than triple MicroStrategy’s 218%, according to Morningstar.
Still, there is an additional problem with leveraging MicroStrategy as a stock. As of Nov. 25, the company held 386,700 Bitcoin, valued at about $37 billion. But the stock has a market capitalization of $89 billion, more that two times its Bitcoin value, meaning investors are paying a premium to invest alongside Saylor.
“The Michael Saylor effect you see in a lot of stocks right now,” Tuttle says. “Certainly you see it in Tesla with Elon Musk. To an extent, you see it in Nvidia with Jensen Huang. You’ve got these celebrity CEOs that add to the valuation.”
That only amplifies the risk. “If you look at it purely as a fundamental analyst, there’s no way MicroStrategy is worth this price,” Tuttle acknowledges. But he and Jablonski have hedged their bets: Both T-Rex and Defiance offer 2x inverse MicroStrategy ETFs that rise when the stock falls. Yet the larger of the two, T-Rex 2x Inverse MSTR Daily Target (MSTZ), has only $155 million in assets.
The Bitcoin and Michael Saylor allure persists. For now.
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