By Jack Pitcher and Gregory Zuckerman
Three months ago, Matthew Tuttle was a Wall Street bit player, running a small investing firm from his Connecticut home.
Now he's managing billions on behalf of everyday investors betting on bitcoin in what may be the market's riskiest territory. Some in finance warn that just a few sharp down days could cause investors in his exchange-traded fund, known as the T-Rex 2X Long MSTR Daily Target ETF, ticker symbol MSTU, to face serious troubles.
Tuttle's fund makes huge bets on the shares of MicroStrategy, the tech company that has become a day-trader favorite after ditching its original business model in favor of borrowing billions to purchase bitcoin.
Through complex financial derivative contracts, Tuttle's fund aims to double the daily returns of MicroStrategy -- itself one of the most volatile stocks in the U.S. Thrill-seeking investors have poured into the fund in the months since its launch, at one point pushing its assets to $3.4 billion.
The fund's rapid growth is creating new pressures. Last month, the fund reached the limit of exposure its trading partners were willing to take on -- making it impossible to carry out the primary investment strategy described in its original prospectus. As a result, the fund is now using an options strategy that's unconventional for single-stock ETFs to produce levered returns.
On several recent days, the fund has failed to deliver on its goal of doubling the daily return of MicroStrategy stock. Skeptics say this turn raises questions about whether an investment that Tuttle acknowledges is among the riskiest in the market is even more fraught with danger than it might appear.
"We estimate the probability of the leveraged MicroStrategy ETFs going bust in the next year at between 20% to 50%," said Victor Haghani, who runs the investment firm Elm Wealth. Haghani, who arrived at the high end of his estimate by projecting the ETF's performance if MicroStrategy's current volatility holds for a year, might know: He was a founding partner of the highly leveraged hedge fund Long-Term Capital Management, which collapsed in 1998.
For his part, Tuttle believes he has arrived at the station that's right for him. After years working in insurance, finance and wealth management, he determined that trading is at the center of his skill set and that providing investment opportunities to like-minded people is the right fit for him.
"I gravitate to self-directed retail investors because that's what I am, " says Tuttle, 55 years old.
The tale of MSTU -- the launch of a leveraged bet on a volatile stock that is itself a leveraged bet on bitcoin, which prospers and then struggles to digest its own gains -- is one of the signal market stories of 2024. Gains in riskier assets have surprised and at times alarmed longtime investors and analysts who see parallels to the dot-com boom and bust a quarter-century ago.
Long road to ETFs
After working for various insurance companies and brokerage firms in the early part of his career, Tuttle started his own wealth-management firm in 2003 in Greenwich, Conn. He advised families and others on financial planning, eventually growing the firm to $120 million in assets.
In 2015, he started an investment firm, partly because he prefers trading to portfolio construction. Tuttle hired a handful of remote employees and began launching ETFs representing specific bets. His amplified-ETF approach appealed to small investors eager to make big wagers.
In 2021, Tuttle started introducing levered and inverse-ETFs. He started with one that bet against the blank check vehicles known as special-purpose acquisition companies, deciding those products were "garbage." The ETF soared in value when SPACs crumbled in 2022. He rolled out an inverse fund that bet against Cathie Wood's ARK fund, which also rose sharply in value when her fund fell.
"I'm a big believer in reversion to the mean," or the tendency for asset prices to fall back to earth after a huge run-up, Tuttle explains.
The inverse-ARK fund grew to more than $500 million in assets at its peak, before shrinking. Most of the 20-plus other funds Tuttle has launched are tiny. Some have closed. Tuttle's firm, which charges a lucrative 1% fee for many of its actively managed ETFs, managed about $1 billion this summer, making it a small-time asset manager.
That all changed in September after Tuttle launched two new ETFs with partner Rex Shares, one that aimed to give investors twice the return of MicroStrategy, and the other to produce returns equating twice the inverse of the stock's performance. The latter allows skeptics to bet that the shares can't keep going through the roof.
A competing small asset manager, Defiance ETFs, had done the same thing a month earlier, though Tuttle's fund quickly grew bigger thanks to initially offering more leverage than the other product.
Both managers' products caught fire in November, attracting traders trying to ride the bitcoin rally. The ETFs were among the most traded funds in the U.S. for several days, despite being a fraction of the size of the largest index funds. The excitement reached a fever pitch Nov. 26, when Tuttle's fund raked in $845 million of new investor money in a single day -- a staggering sum for what was then a $2 billion fund.
The windfall exposed a shortcoming in Tuttle's strategy.
Not enough swaps
Funds that offer leveraged exposure to broader baskets of stocks have been around for years. Their riskier cousin, the leveraged single-stock ETF, was approved by U.S. regulators in 2022.
Both strategies typically produce their juiced returns through the use of financial contracts known as total return swaps. In exchange for a fee, a market maker will pay a swap holder the exact daily return of an asset, allowing a fund to double the daily performance of a stock or index with precision.
With his assets soaring in November, Tuttle suddenly couldn't get anywhere close to the amount of swap contracts he needed from his prime brokers, or the firms that provide securities lending and other services to professional investors. Competitor Defiance ETFs faced the same problem.
Neither asset manager has relationships with the prime brokerages at major Wall Street banks that would have the capacity to write the swaps they need. Analysts say the risk-averse banks might not be interested anyway.
That has left the firms to turn to the options market for leverage, both Tuttle and Defiance CEO Sylvia Jablonski said.
The use of options -- which wasn't a strategy described in Tuttle's original fund prospectus -- introduces a new set of risks. Prices fluctuate, and options on a volatile stock can be costly, eating into a fund's returns.
Both MSTU and Defiance's competing fund, MSTX, have had substantial "tracking errors" in the days since they began using options, at times leaving their investors with larger-than-expected losses on down days and smaller-than-expected gains on up days.
"These two firms have created something that it is now clear the market can't handle," said Dave Mazza, CEO of competitor Roundhill Investments. "It's really a risk to do this with options. You can't control the market."
Previous single-stock ETFs that used swaps have a strong track record of performing as advertised, so investors on social media were surprised to see the performance of the MicroStrategy funds diverge in recent days.
Both "2X" MicroStrategy funds have recently posted daily losses greater than three times the underlying stock, while posting gains of less than double.
Tuttle says he isn't concerned that the leveraged fund hasn't always been providing twice the return of MicroStrategy, despite the fund's name and stated goal.
"The prospectus says it targets twice the return, it says 'targets' for a reason," he says. "We're going to try every day to get two times, some days we won't quite get there."
Both funds have also had to update their prospectuses to further warn about options-related risks.
Tuttle says it is feasible for him to keep running the fund with options, despite the challenges of that strategy.
"You can do it, if you know how to manage an options portfolio," he says.
Write to Jack Pitcher at jack.pitcher@wsj.com and Gregory Zuckerman at Gregory.Zuckerman@wsj.com
(END) Dow Jones Newswires
December 09, 2024 05:30 ET (10:30 GMT)
Copyright (c) 2024 Dow Jones & Company, Inc.
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