How are most ETFs managed?

How are most ETFs managed?

Long only ETFs that do not use leverage should have the same sort of downside risk as a mutual fund investing in the same asset or index. This varies from year to year with volatility and market trends. 

Investors buying an ETF in a standard brokerage account, without using any personal leverage or margin through CFDs, spread bets or other means, cannot lose more than 100%.

The ETF itself could lose 100% of its value, though this is quite rare. Politics, geopolitics, sanctions and counter-sanctions have historically caused equity market losses of effectively 100%. In 2022, Russian ETFs lost virtually all of their value after sanctions, and Russia’s counter-sanctions. (It remains to be seen whether some sort of reciprocal swap deal announced in March 2024, whereby Russian individuals invested in foreign stocks get some recovery in return for foreign individuals invested in Russian stocks, will lead to any recoveries for either or both sides). Over the past century, various revolutions including the Russian revolution of 1917 caused a 100% loss for shareholders, and would have wiped out ETFs wholly exposed to Russia had they existed at the time.

Politics apart, losses approaching or reaching 100% are most likely to happen for an inverse/short ETF, and/or a leveraged one, because they can end up with a loss larger than the ETF NAV. Basically if a short rises by more than 100%, an unleveraged position in it can be worth less than zero. For instance, the ETF with ticker XIV, was short of the VIX index of US equity volatility. When the VIX more than doubled in value in the “volmageddon” of February 2018, XIV was shut down with no return of capital to investors. 

A double or triple leveraged inverse ETF could lose 100% even more easily. A double leveraged inverse ETF starts off with 200% short exposure so if the asset rises by at least 50%, it would lose 100%. A triple leveraged inverse ETF starts off with 300% short exposure, so if the asset rises by at least 33%, it would lose 100%. The reason why these products continue for years is that they reset exposure daily and it is rare for an asset to rise by more than 50% or 33% in a day. 

A double, triple or more leveraged long ETF could also see large losses in a deep bear market. Leverage Shares has launched a 5x leveraged S&P 500 ETP. On Black Monday October 19^th 1987, the US equity market dropped 22.6%. Though 5x levered ETFs did not exist at the time, it is reasonable to estimate that a daily reset 5x levered ETF would have lost all of its value on that day, since 5 times 22.6% is 113% .  

A 3 times leveraged Nasdaq 100 ETF, QQQ3, lost about 80% between November 2021 and December 2022.