One of the most daunting challenges arises when Odysseus crosses paths with the sirens. The half-bird half-human creatures were extremely dangerous as their singing would lure sailors into steering their boats onto the rocks. On the one hand, Odysseus had the brilliant idea of plugging his crew’s ears with wax, impeding them from hearing the deadly song. On the other hand, his thirst for knowledge led him to take great risks. He could not resist the temptation of hearing the sirens’ song, but he took the precaution to tie himself to the mast. This allowed him to listen to the deadly song without being able to jump into the water and drown. He instructed his crew to not untie him as he would probably not be able to control himself. Whilst listening to the song, Odysseus could not resist the tempting appeal from the sirens; not only did he try to untie himself from the mast, but he also begged his crew to untie him. The crew followed Odysseus’ instructions to ignore his own pleas and the boat managed to pass through the sirens’ islands. The legend says that the sirens plunged into the sea and died as they failed to kill Odysseus despite him having heard their deadly voices.
Today’s investor is a modern-day Odysseus: travelling across a sea of continuous information, he aims for stability and predictable outcomes but is also tempted by the desire to achieve more by allocating resources to investments that promise unrealistic returns.
In this vein, our May monthly newsletter focused on Korean semiconductors’ companies and the incredible returns they generated for investors. Since then, the subject continues to make headlines as the Korean equity index, the KOSPI, still exhibits an impressive volatility. The index is now plagued by an extreme concentration in two stocks, both backbones of the semiconductors sector. In July this interconnection dragged the KOSPI and the Philadelphia Semiconductors index down respectively by 22% and 28%. A correction was eventually inevitable as both indices had doubled between the beginning of the year and mid-June. This month sell-off in the semiconductor market offers us a unique opportunity for an indepth analysis of the forces raging beneath the surface of the financial markets’ waters.
Looking at the fundamentals, analysts have not downgraded earnings’ expectations for semiconductors companies. The expected growth remains extremely elevated and current valuations are therefore not outrageously expensive; but companies are now required to live up to their expectations. More specifically, the recent negative momentum coincides with investors’ doubts about the sustainability of AI related expenses. Since Chat GPT’s launch in November 2022, the hyperscalers drastically increased their capital expenditures to compete in the AI race. The numbers are staggering: the consensus now expects capex spending to reach USD 750 billion in 2026 which would imply an increase of 84% from last year’s numbers. Earlier this year, the expectation for capex was USD 550 billion, but recent earnings calls made analysts reassess it upward. For next year, the expected capex of US hyperscalers should reach USD 920 billion, a massive 22% increase compared to 2026. The earnings published this month testified returns generated from these investments, but more will be expected to justify the magnitude of the amounts injected.
In this context, investors’ fears have been fueled by the nature of the investments. Hyperscalers, whose debt historically remained at low levels, began to release a tsunami of debt on the financial markets. AI exposure is now no longer confined to the equity market but is also borne by fixed income investors as Goldman Sachs estimates that almost USD 500 billion of AI-related debt has been issued in 2026. This represents more than 20% of both the investment grade and high yield gross issuance from the beginning of the year.
In this brave new world, the regulators have recently pinned down an additional market volatility compounder: the leveraged ETFs.
These have existed for more than 20 years, but the high riskappetite of equity investors increased their popularity. The first leveraged ETFs were designed to track the daily performance of a standard broad equity index, such as the S&P500, with a coefficient of 2 (both to the upside and the downside). Then, some ETF issuers began applying a leverage factor of 3 while others introduced inverse products tracking the opposite of an index's performance, with factors of 1, 2, or even 3. Today, a broad range of possibilities is offered: commodities, basket of stocks, thematic strategies or even on single stocks.
The semiconductor world has not been spared by the leveraged ETF frenzy, and they have gained increased popularity even among retail investors.
Why is this a problem?
On a systemic level, leveraged ETFs may pose risks to broader financial stability. In July, they have allegedly amplified technology stocks’ sell-off. Large 3x Nasdaq and 3x semiconductor ETFs can reach around USD 100 billion of notional exposure, and their daily rebalancing can drive flows of more than USD 10 billion, which can materially impact underlying stocks and indices in short‑term tradi ng . The long‑to‑short ratio in leveraged ETFs has climbed from a historical ceiling of around 5:1 to about 19:1 across the space. This optimism can feed back into markets: rising prices attract more leveraged long flows, which compound in a trending bull market, but when sentiment sours, the same leverage can accelerate downside moves forcing painful unwinds for ordinary investors whose core portfolios are heavily tied to those sectors.
For this reason, some regulators started to restrict the access to leveraged ETFs, with China explicitly banning leveraged ETFs from its domestic ETF universe and from various trading platforms. This decision was made after many retail investors suffered significant losses trading leveraged ETFs linked to gold. South Korea also took a similar decision after many Korean investors bought leveraged ETFs on KOSPI and on SK Hynix at their respective all-time highs. The Korean regulator decided to halt new listings of single-stock leveraged ETFs, raised the minimum cash deposit for trading such instruments and increased the minimum trading unit to 20 shares. The decision aims to limit the effects of leveraged ETFs on market volatility by making access much harder for retail investors.
From a systemic perspective, it is quite clear that leveraged ETFs are not healthy instruments; but are they useful from an individual perspective? One thing is certain: these are tempting instruments for investors. Who would not want to double his equity returns? Yet, this is not what leveraged ETFs deliver. A 2x leveraged ETF will give twice the daily return of the underlying, but this only holds true on a daily basis. Over longer -term horizon, the return will not be twice the underlying’s.
More concretely, the S&P 500 generated a total return of 87% in the last 5 years whilst a 2x leveraged S&P 500 ETF would have returned 138%, higher than the underlying’s return, but not twice it, as one could have imagined. The more leveraged the ETF and the more volatile the underlying, the further the return may drift from the stated coefficient. A 3x leveraged Nasdaq delivered a 79% return over the last 3 years whereas the standard index returned 89%, nearly 10 percentage points more. It does not seem worth taking such risks, does it?
The greatest winners in the leveraged ETFs trades are the ETF providers themselves. Academic work shows that demand for leverage allows ETF providers to charge higher fees for leveraged exposure because contracting a Lombard loan is operationally cumbersome for many investors. Most standard broad-market ETFs charge between 5 and 15 basis points but leveraged ETFs may charge between 60 and 100 basis points in fees without even accounting for financing and hedging costs.
If an investor like Odysseus cannot resist the alluring promises coming from the leveraged ETF sirens, he needs to restrain himself just like the Homeric hero. Odysseus acknowledged the risk inherent in his goal of listening to the sirens and he acted rationally in response. Where the mythological figure instructed his crew to tie him to the mast and, under no circumstances, to release him before the ship had passed those treacherous waters, the modern investor must adopt the same principle by adopting a rigid bucket approach to avoid the temptation of extremely risky instruments that could cost far more than imagined.
