Global Market Strategist
Chief ETF Strategist
After the spring market low, stocks surged in the second quarter. Momentum outperformed quality by 32 percentage points, semiconductors rose 88% and investors were ravenous for equity exposure. This market exuberance manifested itself in different pockets, with massive inflows into leveraged and thematic ETFs. However, the momentum unwind in Q3 reminds investors it is important to understand the mechanics and risks of these strategies for long-term investors.
Leveraged ETFs: Amplified upside… and downside
The leveraged ETF universe is about $200bn, but growth has been explosive recently, with AUM rising 70% in 2Q alone. This year, 320 new leveraged ETFs have launched (half on single stocks), nearly doubling the available strategies. It’s no surprise that about 75% of leveraged ETF AUM is tech or tech adjacent. While investors have clamored for these strategies, an important distinction is how they are intended to be used: as short-term trading vehicles.
Why? Consider a $100 stock that rises 10% on day one to $110 and falls 10% on day two to $99. Now consider a 3x leveraged ETF on that stock that rises 10% on day one to $130 and falls 10% on day two to $91. Nearly nine times the pain despite the unlevered stock ending in almost the same place it began. Extend that pattern over weeks or months of volatility, and the effect compounds.
For investors who have used leveraged ETFs for longer time horizons, market drawdowns are not for the faint of heart. In 2022, the S&P 500 corrected 24.5%; a triple-levered S&P 500 ETF was down 64%. The S&P 500 fell 18.7% when reciprocal tariffs were imposed last year; a triple-levered S&P 500 ETF was down 49%.
Volatility is not only amplified for individual investors, but also for the broader market. In volatile markets, daily rebalancing can mechanically force buying into rallies and selling into declines, amplifying flows and market volatility.
Thematic ETFs: Flows follow performance… in both directions
Similarly, select thematic ETFs have had a resurgence in popularity, which often occurs in momentum-driven markets. Through the first 7 months of 2026, top themes brought in $65 billion, dominated by just two funds. However, during less exuberant markets, top themes have struggled to attract inflows because flows tend to follow performance. Some themes, like infrastructure and more recently defense, have garnered enduring flows and strong performance (proxied by the performance of the largest fund in the theme). However, themes like clean energy and electric vehicles gain traction only to lose favor as the realities of achieving these innovations set in. This year, 3 of the top 5 themes – AI (-11.1%), nuclear (-21.3%) and space (-29.6%) – are down double-digits since their peak inflows.
Ultimately, leveraged and thematic ETFs are about expressing high conviction views in a portfolio. For long-term investors, rather than taking on the volatility and risk inherent in these strategies, they may be better served leaning into active ETFs with broader investment objectives rooted in fundamental analysis.