South Korea Warns of Risks from Leveraged AI ETFs

The Bank of Korea published a report on Thursday (10) that raises a yellow flag regarding a phenomenon spreading across markets worldwide: the rush of retail investors towards leveraged ETFs linked to the artificial intelligence sector. According to the monetary authority, the significant increase in these investments has caused considerable volatility in the domestic stock market.

The warning came a day after the Kospi index rose by 1.4%. On Thursday, the index gave back some gains, closing down 0.25% at 7,033.92 points. Key semiconductor stocks, such as SK Hynix and Samsung Electronics, fell by 0.16% and 0.19%, respectively.

The backdrop is global, but the intensity of the problem seems particularly acute in South Korea, where retail investors have a history of concentrated bets on market themes, a phenomenon known as the "ants" movement during the pandemic.

Leveraged ETFs are exchange-traded funds that use derivatives to amplify the daily return of an index or benchmark asset. For example, a 2x leveraged ETF on a technology stock aims to deliver double the daily variation of that stock. In an uptrend, the gain is amplified. In a downturn, the loss is also.

The problem is that these products are not designed for long-term positions. The daily compounding effect erodes returns over time, especially in volatile markets. An asset that rises by 10% and falls by 10% the next day does not return to its starting point in a leveraged ETF. As previously discussed in analyses of financial markets, this type of instrument functions as a tactical tool, not as an investment strategy.

With the AI boom driving semiconductor and big tech stocks over the past two years, South Korean investors have concentrated positions in these ETFs, often without understanding the daily leverage mechanism. The South Korean central bank identified that this behavior has begun to distort price formation in the domestic market.

In addition to the warning about ETFs, the Bank of Korea reiterated that it will assess the timing and pace of new interest rate hikes. The decision will be guided by three variables: inflation, economic evolution, and financial stability conditions.

The mention of "financial stability" is not casual. When a central bank highlights this pillar alongside inflation and growth, it usually signals that speculative excesses are on the radar of monetary policy. It is the kind of language that precedes macroprudential measures, such as limits on retail exposure to leveraged products or increased margin requirements.

In Japan, the Bank of Japan (BoJ) also reinforced its contractionary tone. Board member Kazuyuki Masu stated that the BoJ will continue to raise its base rate to prevent inflation from exceeding the 2% target. Market expectations point to a new interest rate hike as early as next week, something that would have been unthinkable two years ago in a country that practically invented zero interest rates. Nevertheless, the Nikkei rose by 0.2%, closing at 65,270.95 points.

The regional scenario was one of widespread caution. In mainland China, the Shanghai Composite fell by 0.4% to 3,934.40 points, while the Shenzhen Composite dropped by 0.95%. In Hong Kong, the Hang Seng fell by 1.3% to 24,954.47 points. Taiwan also closed in the red, with the Taiex losing 0.5%.

In Oceania, the Australian stock market had the worst performance of the day among the major markets in the region, with the S&P/ASX 200 declining by 1.03%.

The mixed performance reflects an environment where enthusiasm for artificial intelligence is beginning to meet resistance from regulators and central banks. The narrative that AI is transformative for the economy remains intact, but the financial instruments created to ride this wave are generating side effects that monetary authorities cannot ignore.

The South Korean movement has a direct parallel with what is happening in Brazil. In recent months, B3 has listed a series of thematic ETFs and BDRs of international ETFs linked to artificial intelligence, semiconductors, and big techs. Although most are not leveraged, the principle of risk concentration is the same.

Investors who allocate a disproportionate share of their portfolio to a single theme, no matter how promising, are exposed to sector corrections that can be severe. The semiconductor sector itself, as discussed in recent coverage, faces issues of overcapacity and geopolitical tensions that add layers of risk.

The warning from the South Korean central bank serves as a reminder: the investment thesis in AI may be correct without the chosen instruments for exposure being appropriate. HD Hyundai Heavy Industries, for example, announced an investment of $800 million in energy engines and small nuclear reactors to supply AI data centers. Despite the solid fundamentals, its shares fell by 3.8% in trading. The market does not always reward the narrative in the short term.

For those investing from Brazil, the main lesson is discipline: understand what you are buying, avoid leverage in long-term products, and do not confuse a megatrend with a safe bet. These are different things.