AXS Investments recently launched leveraged single-stock exchange-traded funds (ETFs). To this end, AXS has targeted some of the more heavily traded stocks across several industries.
One stock AXS has targeted is one I own, PayPal Holdings (PYPL 1.39%). It has launched two PayPal-related ETFs, both on the bull and the bear sides of the trade. However, given the nature of leveraged ETFs, I'll keep my position in PayPal stock and encourage other long-term investors to do the same.
Single-stock ETFs described
AXS's two PayPal-related ETFs are the AXS 1.5X PYPL Bear Daily ETF (PYPS) and the AXS 1.5X PYPL Bull Daily ETF (PYPT). As the names imply, each fund aims to capture 1.5 times the performance of PayPal, be it on the bear or bull side.
Also, AXS hasn't limited itself to PayPal. It launched similar leveraged ETFs for Tesla, Nvidia, Nike, and Pfizer.
The ETFs work the same way, regardless of the stock. If the value of PayPal stock rises by 2% in one day, the value of the bull ETF will increase by 3%. Conversely, the value of the bear ETF would drop by 3%. It will have the opposite effect on each ETF if PayPal stock falls by 2%.
I purchased PayPal as a long-term investment, so these ETFs don't suit my investment style. In fairness to AXS, it states on its website that these ETFs are suitable as short-term investments only. Nonetheless, the structure of these investments suggests they'll suit few investors well, regardless of one's bullish or bearish view on PayPal stock.
The case against the PayPal ETFs
Admittedly, amid the bear market, I've encouraged investors to make friends with PayPal. Given its first-mover status in fintech, the extent of its ecosystem, and its price-to-earnings ratio (P/E) of 26, I think it can serve investors well over time, especially considering that it sells at a 75% discount to its 52-week high.
But assuming my thesis is correct, PayPal stock will probably outperform the AXS 1.5X PYPL Bull Daily ETF longer term, despite its leverage.
The issue has to do with daily resets on leveraged ETFs. Such resets can benefit holders of the PayPal bull ETF if the stock rises every day, the one scenario where the ETF would return 1.5 times as much as PayPal.
However, even the highest-conviction stocks suffer periodic down days, and as stated before, the bull ETF would lose 1.5 times as much value as its underlying stock in this case. Since the ETF resets at a lower value, its 1.5X leverage produces less return on up days than it would have had it retained its higher value. Even if it rose in subsequent trading days, it may underperform PayPal stock or, at the very least, fail to deliver 1.5 times as much return over time.
This should worry PayPal bulls since, on Feb. 2, PayPal lost 24.6% of its value following Q4 earnings. Had the bull ETF existed then, it would have lost 36.9% of its value. Since PayPal fell further from this point over the next five months, bull ETF investors would likely have never recovered.
What's an investor to do with PayPal ETFs?
Regardless of one's ability to predict the behavior of PayPal stock, investors will likely not win with either PayPal ETF. Even if one can guess the direction of PayPal correctly, subsequent down days for either ETF will erode their values over time.
For this reason, one's success depends not only on a long-term case for or against PayPal stock, but also on an investor's ability to avoid down days in the ETF. Since such declines are nearly impossible to avoid, interested PayPal investors would likely earn higher returns by simply buying PayPal stock.